Question

Which is CORRECT about information asymmetry and adverse selection

1. Information asymmetry refers to the situation when buyers have more information on the product than the sellers.
2. Information asymmetry is the result of adverse selection.
3. In a used car market, if sellers with good cars are unwilling to sell at a large discount, then only bad cars will get sold. This suboptimal outcome is so-called “adverse selection”.
4. Due to information asymmetry, market investors interpret firm’s SEO announcement positively because they believe insiders consider the firm undervalued.

Answer 1

a.

It is a correct answer

information asymmetry refers to the situation when buyers have more information on the product than the sellers.

when two-party don't have equal information called information asymmetry.

b.

Information asymmetry is the result of adverse selection. is incorrect

Adverse selection is a result of the asymmetry information. Adverse selection is a situation in which one party in the deal has more accurate information than other parties mean one party has more information than another party

c.

In a used car market, if sellers with good cars are unwilling to sell at a large discount, then only bad cars will get sold. This suboptimal outcome is so-called “adverse selection”. is correct .because the only seller knows which is a good car and which is a bad car, the seller has more information than the buyer. seller will sell bad car first is an example of adverse selection

d.

Due to information asymmetry, market investors interpret the firm’s SEO announcement positively because they believe insiders consider the firm undervalued is the incorrect statement.

Managers tend to issue equity when the firm is overvalued. investor learn that the firm is overvalued and thus price drops