Adverse Selection
Adverse selection occurs when hidden pre-contract information changes who trades, borrows, or buys insurance, worsening the pool or terms offered.
Finance concepts explaining how hidden information, delegated authority, and conflicting incentives affect contracts, pricing, monitoring, and risk.
Information, Agency, and Market Frictions examines why financial contracts can produce inefficient outcomes when parties have different information, incentives, or decision rights. These concepts help analysts evaluate lending, insurance, investing, corporate governance, compensation, and market design without assuming that every party observes the same facts or bears the same consequences.
The pages are related but not interchangeable. Asymmetric Information describes an information imbalance. Adverse Selection asks how hidden pre-contract information changes participation. The Principal-Agent Problem focuses on delegated decisions when the agent’s incentives or information differ from the principal’s.
| Concept | Main question | Finance application |
|---|---|---|
| Adverse Selection | Does hidden risk or quality change who accepts the contract? | Insurance pools, lending, asset sales, securitization, and market making |
| Asymmetric Information | Who knows what, when, and with what reliability? | Disclosure, due diligence, underwriting, pricing, and verification |
| Principal-Agent Problem | Can a delegated decision-maker pursue interests different from the owner or beneficiary? | Managers and shareholders, advisers and clients, servicers and investors |
| Agency Cost | What monitoring, bonding, incentive, or residual loss follows from the conflict? | Audit expense, controls, compensation design, and value leakage |
Do not use an information or agency label as proof of misconduct. The analytical task is to identify the mechanism, timing, evidence, incentives, and financial consequence. These pages provide general economic and financial education, not a legal conclusion or individualized financial recommendation.
Choose a subsection first. Deeper term pages live inside each subsection, which keeps large topic hubs readable.
Adverse selection occurs when hidden pre-contract information changes who trades, borrows, or buys insurance, worsening the pool or terms offered.
Agency cost is the economic cost of monitoring, bonding, and remaining conflicts when one party delegates financial decisions to another.
Asymmetric information exists when parties hold different relevant information, affecting pricing, contracts, credit, insurance, governance, and trading.
The principal-agent problem arises when a delegated decision-maker has different incentives or information, creating governance, compensation, and risk challenges.