ECON 3430 Lecture Notes - Lecture 8: Global Financial System, George Akerlof, Adverse Selection

• School: York University
• Department: Economics
• Course: ECON 3430
• Professor: Brenda Spotton- Visano

Document Summary

Inability to diversify will subject you to risk: financial intermediaries have evolved to reduce transaction costs. Expertise: asymmetric information: adverse selection and moral hazard, asymmetric information: one party has insufficient knowledge about the other party involved in a transaction, two types of asymmetric information: Moral hazard arises after the transaction: agency theory analyses how asymmetric information problems affect economic behaviour, adverse selection: the lemons problem, george akerlof, the market for lemons, qje (1970) Free-rider problem: government regulation to increase information. Not always works to solve the adverse selection problem, explains fact 5: financial intermediation. Experts in producing information, can determine good risks from bad ones, no issue with free riding. Explains facts 3, 4, & 6: collateral and net worth (or equity capital) Explains fact 7: how moral hazard affects the choice between debt and equity contracts, the principal-agent problem. Agent: more information (manager: separation of ownership and control of the firm.