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In: Finance
what are the impacts of information asymmetry, adverse selection and moral hazard on financial services
what are the impacts of information asymmetry, adverse selection and moral hazard on financial services
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Expert Solution
Information asymmetry: Information asymmetry occurs when one party to an economic transaction have more knowledge than the other party. This can have both advantages and disadvantages. The advantages are that when a group of workers in a particular field learn more about it then they become more productive and are of greater help to people from other fields like a financial advisor having more knowledge about the financial products is good for the client he is catering to. The disadvantages are that this can lead to cheating with the clients who procure the services. It is possible that the financial advisor can knowingly hide some vital information from the client that can lead to a loss for the client.
Adverse selection: Adverse selection is a situation where the information asymmetry is exploited by the party which is having more information. For example, when a person is buying health insurance, he has more knowledge about his health than the insurer and thus he can exploit the insurer by not providing the whole information about his health leading to a potential loss for insurer.
Moral hazard: Moral hazard is a position where a party to the contract has a lack of incentive to guard against potential losses as it is protected from the consequences. For example, big investment banks can take huge risks in their financial transactions knowing that if they get into distress they will be bailed out by the government like in the 2008 financial crisis.
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