Adverse Selection
Categories: Financial Theory, Trading, Investing
A.K.A. "asymmetric information," this occurs when one party to a transaction (either buyer or seller) has information that the other lacks, especially regarding product quality, ability to pay, or other factors that may otherwise alter decision-making.
If Little Johnny plans to execute a "dine and dash," the restauranteur is expecting to be paid for the meal served, only to be adversely surprised when Little Johnny disappears without settling up (or tipping). Other examples would be Shawn White buying health insurance without mentioning his X-Games profession, a sleazy used car salesman doing stereotypical, sleazy used car salesman stuff, or the guy running the "three card Monty" game on the corner. More often, though, it is the seller who is aware of issues with the product they are hawking, which is why the phrase "caveat emptor" ("buyer beware") is more commonly heard than "caveat vendor" ("seller beware").
Related or Semi-related Video
Finance: What is Asymmetric Information?25 Views
Finance allah shmoop what is asymmetric information Well asymmetry happens
when two sides of something aren't equal think giant red
wood and we'd regular crab and fiddler crab recumbent bike
and a eunice cycle well in the financial world asymmetric
information exists when one side of a transaction think inside
trader scumbag who collects briefcases full of cash from somalia
in overlords versus a normal joe six pack investor trying
to fairly participate in the stock market So he has
a pension to retire on while bouncing great grandchildren on
his newly installed robotic knees Well discount needs don't go
there Your summer college job is cleaning the house of
the ceo of whatever dot com currently trading at eighteen
bucks a share as you empty her garbage one night
pushing away adult diapers in the process Yes she has
a lot of pressure on the job on this conference
calls and saying ooh a lot I push that away
You realize that microsoft is buying her company for thirty
dollars a share You then by a ton of stock
at eighteen bucks you had a symmetric information because you
dug through the trash and you found the memo from
whoever the ceo is of microsoft these days to her
and that was bad You didn't have to act on
that information like you could have just done a whole
lot of nothing and not repeated it to anyone and
left the stock at eighteen dollars until it was all
in the news at thirty and moved on and still
have your job cleaning her trash Having inside information isn't
illegal but doing something to benefit yourself tor You know
your loved ones is illegal So if you trade based
on inside asymmetric information well then you just committed a
felony It's called insider trading And while here's hoping you
look good and either orange or black or or both