Adverse Selection and Moral Hazard in the Financial Markets 3 2. Adverse Selection: Akerlof’s Model “The Market for Lemons” 5 1. Adverse Selection and Moral Hazard in the Financial Markets Adverse selection is a problem created by asymmetric information. Asymmetric information means that the buyer and seller of a product have different information about the product in question. This may be a car‚ a financial instrument/loan or any tradable item‚ but in financial terms it is easiest to imagine
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The Hazard of Moral Hazard 09.01.09 - 12:00 AM | James K. Glassman When someone insures you against the consequences of a nasty event‚ oddly enough‚ he raises the incentives for you to behave in a way that will cause the event. So if your diamond ring is insured for $50‚000‚ you are more likely to leave it out of the safe. Economists call this phenomenon “moral hazard‚” and if you look around‚ you will see it everywhere. “With automobile collision insurance‚ for example‚ one is more likely to venture
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Chapter 14 Financial Structure and International Debt ( Questions 1. Objective. What‚ in simple wording‚ is the objective sought by finding an optimal capital structure? When taxes and bankruptcy costs are considered‚ a firm has an optimal financial structure determined by that particular mix of debt and equity that minimizes the firm’s cost of capital for a given level of business risk. If the business risk of new projects differs from the risk of existing projects‚ the optimal mix
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SUMMARY Moral Hazard in Equity Contracts: The Principal-Agent Problem The separation of ownership and control involves moral hazard‚ in that the managers (the agents) may act in their own interest rather than in the interest of the stockholder-owners (the principals) because the managers have less incentive to maximize profits than the stockholder-owners do. Tools to Help Solve the Principal-Agent Problem Production of Information: Monitoring Stockholders engage in a particular type of information
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does this mean? What are its implications? Before the 2009 financial crisis banks were conviced that they we’re ｫ too big to fail ｻ Before the 2009 crisis‚ banks were conviced they were too important to fail in the sens that their importance in the market was such that the states could not afford to drop them. Indeed governements can’t let any bank fail because of systemic risk and the need to maintain the confidence in the market and between banks. So the banks favored the short-term
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Moral Hazard A few years ago when Hurricane Katrina wake‚ many people fled the ravaged Gulf Coast were spending disaster relief paid for by taxpayers‚ on tattoos‚ expensive handbags and making trips to their favorite places. In this case the damage has already done and people are using the debit cards issues by FEMA (Federal Emergency Management Agency). The debit cards are issued to buy the necessities like food and clothing. But the damage was done and people misused its money. FEMA swore that
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Financial Market Structure In economics‚ a financial market is a mechanism that allows people to easily buy and sell financial securities‚ commodities‚ and other fungible items of value at low transaction costs and at prices that reflect the efficient market hypothesis. Financial markets have evolved significantly over several hundred years and are undergoing constant innovation to improve liquidity. Both general markets and specialized markets exist. Markets work by placing many interested
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of life dealing with insurance have drastically changed. It all started off so small and as each year progressed‚ insurance companies have steadily increased and made profit with money. Insurance companies continue to remain a mystery to people of how they make their money. Now in the 21st century‚ Insurance companies have definitely taken advantage of their two most important sources of selling insurance and making money. Insurance companies make money from premiums collected from their customers
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Capital Structure and Debt Structure* Joshua D. Rauh Kellogg School of Management and NBER Amir Sufi University of Chicago Booth School of Business and NBER February 2010 *We thank Doug Diamond‚ Anil Kashyap‚ Gordon Phillips‚ Michael Roberts‚ Toni Whited‚ Luigi Zingales‚ and seminar participants at Emory University‚ Georgetown University‚ Maastricht University‚ Rice University‚ Tilburg University‚ the University of California-Berkeley‚ the University of Chicago‚ the University of Colorado
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Asymmetric information and moral hazard are important concepts in understanding the evolution of financial markets Name: Qiwei Sun When we consider the evolution of financial markets‚ information is the thing that we must pay much attention to deal with. Asymmetric information and moral hazard‚ the two important concepts‚ are playing key roles in the information system. Both of them could hinder the development of financial markets. So‚ in order to make the financial markets developing much more stably
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