ECO 301 Lecture Notes - Lecture 18: Financial Transaction, Moral Hazard, Adverse Selection

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Document Summary

When two parties of transaction have different information. This is in part what creates the principal-agent problem (agency theory) Adverse selection: occurs before a transaction takes place, when people who are the most likely to produce undesirable outcomes are the ones who are most likely to engage in the transaction. Someone who had 100% certainty they would not get sick would not purchase health insurance or someone with the money to pay for a transaction outright would not need a loan. Moral hazard: occurs after the financial transaction takes place, when the seller of a security has an incentive to hide information and engage in activities that are dangerous for the purchaser of the security. Asymmetric information as a rationale for financial regulation. Bank panics and the need for deposit insurance: fdic: short circuits bank failures and contagion, how deposit insurance works (payoff method, purchase and assumption method)