Asymmetric Information
Asymmetric information refers to a situation where one party in a transaction has more or better information than the other, leading to potential imbalances and inefficiencies in the market. This can result in adverse selection and moral hazard, where one party takes advantage of the information asymmetry to the detriment of the other. In economics, addressing asymmetric information is crucial for ensuring fair and efficient markets.
6 Key excerpts on "Asymmetric Information"
eBook - ePubRetail Banking
Business Transformation and Competitive Strategies for the Future
- A. Omarini(Author)
- 2016(Publication Date)
- Palgrave Macmillan(Publisher)
...There are generally two manifestations of Asymmetric Information in the financial services industry. These are called ‘adverse selection’ and ‘moral hazard.’ We describe each of these concepts in detail. 1. Adverse Selection or simply ‘incorrect’ or ‘bad choice’ generally arises when one party to a transaction has hidden characteristics. For example, a borrower has concealed certain facts about his or her true financial position, and they remain hidden from the potential lender. This creates a problem for the supplier of funds in that it cannot unambiguously differentiate between good-quality and bad-quality borrowers. A ‘lemons problem’ can arise. Let us assume that a lender cannot easily differentiate good-quality borrowers from bad-quality borrowers. The lender decides to charge the same borrowing rate to all potential borrowers. This is an average rate between the rate that is charged for good-quality borrowers and the rate that is charged for bad-quality borrowers. But we now have a major problem. Good-quality borrowers will find the borrowing rate too expensive, while the bad-quality borrowers will see the borrowing rate as very attractive when compared to their true risk status (only known to them). Hence, good-quality borrowers will exit the market. The lender will be left with only bad-quality borrowers. This is called ‘the lemons problem.’ It is also called ‘adverse selection.’ If the customer has less information about the banking product than the bank official, then the customer may make an incorrect choice. Note that this problem may occur before the transaction actually takes place. We can summarize as follows: if the customer has less information than the bank official, and this is information asymmetry, then the customer may choose incorrectly – adverse selection. 2. Moral hazard occurs after the transaction (such as the monitoring stage)...
eBook - ePubIntermediate Microeconomics
A Tool-Building Approach
- Samiran Banerjee(Author)
- 2014(Publication Date)
- Routledge(Publisher)
...Chapter 15 Asymmetric Information Information asymmetry deals with transactions where one party possesses private information, i.e., information that is not known to the other party. In this chapter, we study two canonical models covering the two basic types of information asymmetry, hidden action and hidden information. In hidden action (or moral hazard) models, there are two parties called a principal and an agent in a vertical relationship. The principal (henceforth assumed to be female) employs the agent (a male) to undertake some action that she cannot observe. Undertaking the action is costly, so the agent has an incentive to shirk. The principal has to write a contract based on the observable output generated by the agent so as to induce him to undertake an action that is optimal from her perspective. While she runs the risk of not compensating him enough to motivate him to work hard, he runs the risk of working hard but getting inadequately compensated because hard work is not perfectly reflected in the output generated. Thus principal-agent contracts are predicated on optimal risk-sharing between the two parties. In hidden information (or adverse selection) models, typically there is one principal and many heterogeneous agents. Each agent knows his own type but the principal cannot distinguish one agent type from another...
eBook - ePub- Chris Jones(Author)
- 2008(Publication Date)
- Routledge(Publisher)
...This is referred to as the mutuality principle that holds in all the consumption-based asset pricing models examined earlier in Chapter 4. We look at insurance with common (symmetric) information in Section 5.1 and then extend the analysis by introducing Asymmetric Information in Section 5.2. Consumers will fully insure against individual risk in a frictionless competitive equilibrium when traders have common information and state-independent preferences. We use this as a benchmark to identify the effects of trading costs and Asymmetric Information. Consumers choose not to fully insure when trading costs raise the price of insurance above the probability of incurring losses. When they are minimum necessary costs of trade the competitive equilibrium outcome is Pareto efficient, where expected security returns rise to compensate consumers for the cost of eliminating individual risk from their consumption expenditure. A number of government policies, including price stabilization schemes and publicly funded insurance, are justified as ways to overcome the effects of Asymmetric Information on private insurance. Moral hazard and adverse selection are the most widely cited problems. With moral hazard consumers have the ability to reduce their individual risk by undertaking costly self-protection. Whenever marginal effort, which cannot be observed by insurers, is not reflected in the price consumers pay for insurance, they less than fully insure. Adverse selection occurs when there are consumers with different probabilities of incurring losses that insurers cannot costlessly identify and separate. Low-risk types suffer from highrisk types buying low-risk policies. This imposes externalities on low-risk consumers. At one extreme high-risk types may prove too big a problem for the existence of a private insurance market. These are the most common reasons cited for incomplete insurance markets...
eBook - ePubGame Theory in the Social Sciences
A Reader-friendly Guide
- Luca Lambertini(Author)
- 2011(Publication Date)
- Routledge(Publisher)
...This aspect is also intertwined with (and, to a significant extent, conditioned by) the endogenous construction of reputation by informed players, on which uninformed ones can rely, and that contributes to shape the outcome of a game. I will start out by showing you the basic elements of Asymmetric Information. Then, I will pass on to games taking place under incomplete information. Finally, we'll have a look at a solution concept that may be used also when asymmetric or incomplete information is not an issue: forward induction. An aspect that so largely contributes to make forward induction as interesting as it is for game theorists is its relation (or contrast) with the backward induction method you are well acquainted with. 9.1 Asymmetric Information The usual approach to modelling the presence of Asymmetric Information in games consists in viewing the latter as situations where agents have to stipulate agreements concerning a certain transaction or their future behaviour. That is, the heart of the matter is a contract regarding any objects being traded or relevant aspects of the future relationship between these agents in the future. Asymmetric Information can take two forms, alternatively. If asymmetry precedes the transaction (or the stipulation of the contract), we observe a problem of adverse selection ; if instead Asymmetric Information arises after the stipulation of the contract, we are in a condition of moral hazard. For the sake of simplicity, let's confine our attention to two-player games. Under Asymmetric Information, the agent endowed with a larger amount of information is called the agent, while the other is called the principal...
eBook - ePubThe Economics of Health and Health Care
International Student Edition, 8th Edition
- Sherman Folland, Allen C. Goodman, Miron Stano(Authors)
- 2017(Publication Date)
- Routledge(Publisher)
...Certainly information gaps and asymmetries exist in the health sector. They are perhaps more serious for health care than for other goods that are important in household budgets. This makes it useful for the student of health economics to investigate the theory of information asymmetries and its application to health care. However, we should not overlook mechanisms to deal with information gaps. These mechanisms include licensure, certification, accreditation, threat of malpractice suits, the physician–patient relationship, ethical constraints, and the presence of informed consumers. Will a state of relative consumer ignorance preclude high levels of competition? Will health care markets be characterized by a high degree of price dispersion and the provision of unnecessary care or care that is not in the patient’s best interests? Can some of the characteristics of health care markets and the evolution of their institutional arrangements be related to Asymmetric Information? The following sections address these and other questions by beginning with the pioneering work on Asymmetric Information. Asymmetric Information in the Used-Car Market: The Lemons Principle Nobel Laureate George Akerlof (1970) is often credited with introducing the idea of Asymmetric Information through an analysis of the used-car market. Though seemingly unrelated to health care, his classic article is important for two reasons. First, it tells us much about adverse selection and the potential unraveling of health insurance markets. Adverse selection provides a key to our understanding of some major contemporary issues, such as the reasons that some may remain uninsured, or the performance of delivery systems such as health maintenance organizations. Second, Akerlof’s example leads right into the issue of agency. In Akerlof’s model, used cars available for sale vary in quality from those that are still in mint condition to some that are complete lemons...
eBook - ePubShipping Business Unwrapped
Illusion, Bias and Fallacy in the Shipping Business
- Okan Duru(Author)
- 2018(Publication Date)
- Routledge(Publisher)
...5 Information asymmetry What you know and what you do not know! Short-termism • Adverse selection Professional advice • Moral hazard The neoclassical economic model assumes that actors in the market have all available information and that no one benefits from having some extraordinary intelligence. This assumption is the basis for the efficient market hypothesis. Various economists have proposed the Asymmetric Information theory that points to possible irregularities or arbitrage opportunities in the market due to a lack of information, which creates particular advantage to a small selected group that gathers such information (see, for example, Stiglitz and Weiss, 1981). The Asymmetric Information is difficult to detect by outsiders, so you may not even be aware of its existence. However, it is not an overstatement to say that there is always Asymmetric Information in the shipping business. For example, a good prediction or insider information is Asymmetric Information. If everybody knew it, it would not be of value; therefore, only a select group of firms or people have the information. Motives of the directors A typical shipping company has a number of top managers, including the CEO, CFO, COO, and the rest of the C-suite. A board of directors is full of chief execs, the shipowner, and also some independent directors. There is a special kind of relationship between the chief execs and the shipowner. The shipowner requires good profits to compensate him for the huge capital risk he made. The primary considerations when dealing with the shipowner are how patient he is and what period of financial figures he cares about. The majority of shipowners are ‘short-termers’ (whether they accept this or not), and so they usually focus on short-term company figures, such as quarterly profits, while placing less importance on long-term results. Recent market data supports this view. During a peak market, many firms jump on the ship-owning bandwagon...
