Download Additional Notes: Asymmetric Information

FIN 324
Financial Institutions in Hong Kong and
Global Banking
Week 1 Introduction:
Financial System and Financial Intermediation
Mishkin (2012): Chapter 2
Overview of the Financial System
Additional notes: Asymmetric Information
Copyright © 2009 Pearson Prentice Hall. All rights reserved.
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Additional notes:
Asymmetric Information:
A situation where one party to a market
transaction has much more information about a
product or service than the other.
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Moral Hazard Problem:
There is a tendency of one party to a
contract to alter his/her behaviour in ways
that are costly to the other party.
Adverse Selection Problem:
Information known by the first party to a
contract is unknown to the second and, as
a result, the second party incurs major
costs.
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Used Cars: The Market for “Lemons”
A new car loses much of its market
value as the buyers drives it off the
sales lot. The question is, why?
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One explanation relates to inadequate
information about used cars, some
are good and some are “lemons” of
poor quality.
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Consumers cannot distinguish the
good from the defective, so a single
price emerges for used cars, which
roughly reflects the average-quality
car.
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This leads to an adverse selection
problem. Owner of lemons have an
incentive to sell their cars because
the average price is above that for the
low-quality car they own.
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Therefore, there will be
proportionately more low-quality cars
offered than good-quality cars whose
owners hold onto them rather than
offer them at the average-quality
price.
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At the extreme, only lemons would
appear on the used-car market, but
even without the extreme, this theory
offers one explanation of the pricing
of used cars.
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