9-11-09 - Economics 448 Class Notes 9/11/09 Adverse...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Economics 448 – Class Notes – 9/11/09 Adverse selection : where one party to a transaction knows things that: a. are relevant to the transaction b. unknown to the 2 nd party c. Difficult to transfer a. It’s difficult for seller to transfer information, say about a used car. i. If it’s a great car, the seller wants to transfer that information ii. If it’s a bad car or someone who does not know about the quality of the car, it’s hard to transfer that information (especially if you don’t have that information) Adverse selection is Ex ante pre-existing condition You have a pre-existing condition ( you know something before you go into the transaction, like with insurance) Moral Hazard – Where one party to a transaction may undertake certain actions that: a. Affect the other party’s valuation of the transaction b. The 2 nd party cannot monitor perfectly. Moral hazard is ex post after the fact Moral hazrard refers to actions or behavior taken after the transaction o I.e you have insurance so you are more risky Risk-Preference 1. Risk-neutral you don’t care about risk, you just care about the anticipated payoff or return a. You just concern yourself with the size of the expected payoff b. Example: i. 2 investments 1. 15% rate of return, but its REALLY RISKY (you might lose a lot) 2. 6% rate of return – 6% is a sure thing ii. The risk neutral doesn’t care about the risk I am going to go for the highest expected return on my investment 2. Risk-averse Avoiding risky situations a. People will tend to avoid risk and risky situations and investments. They will prefer the option with the lowest risk. b. Example: i. 2 investments 1. 15% rate of return, but its REALLY RISKY (you might lose a lot)
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
2. 6% rate of return – 6% is a sure thing ii. The risk-averse individual will go for the 6% rate of return since it is less risky
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 01/07/2010 for the course ECON 448 taught by Professor Nonnenmacher during the Fall '07 term at Allegheny.

Page1 / 6

9-11-09 - Economics 448 Class Notes 9/11/09 Adverse...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online