Adverse Selection and Moral Hazard



Adverse Selection and Moral Hazard

Introduction

The primary reason why people give their money to financial intermediaries instead of lending or investing the money directly is because of the risk that is present from the information asymmetry between the provider of funds and the receiver of those funds.

Discussion

The risks of adverse selection and moral hazard makes direct financing expensive, especially for small firms, since people are unwilling to lend or invest money in unknown entities. With their expertise in gathering reliable information at reduced cost, financial intermediaries can extend financing to many firms or individuals ...