Research Paper: Credit Default Swaps: Navigating the cross-section with risk sharing

The market for credit default swaps (CDS) has experienced explosive growth in the past. By the end of 2007, the outstanding amount was $62.2 trillion, falling to $38.6 trillion by 2008. A CDS is a type of contract that offers a guarantee against the non-payment of a loan. In this agreement, the seller of the swap pays the buyer in case of a credit event (default) by a third-party. If no default occurs, the seller will have collected a premium from the buyer. CDS are traded for various reasons such as hedging, speculation and arbitrage. Such swaps are non-compliant with Shariah due to involvement in interest (Riba), major uncertainty (Gharar), the trading of risk, gambling elements and prohibited forms of debt trading. An alternative proposed by some scholars is credit sharing in the form of Takaful.

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