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Adverse Selectio1

Adverse Selectio1 - Transactions Costs Transactions costs...

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Adverse Selection, Moral Hazard, and Financial Structure From Last Time Program trading refers to computer-generated orders to buy or sell many stocks at the same time. Excessive volatility occurs when the market price of an asset fluctuates more than its fundamental value does. A stock is mispriced when its market price does not equal its fundamental value, the present value of the expected future returns. Financial Structure Financial structure refers to how borrowers raise funds, the mix of finance between equity (issuing new stocks) and debt and to the source of funds (financial markets or financial intermediaries). Sources of external funds (1970-85): Loans 62% Bonds 30% Stocks 2% Other 6% Loans from financial intermediaries are the most important source of funds. Transactions costs and information costs strongly influence the structure of the financial system.
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Unformatted text preview: Transactions Costs Transactions costs are the costs of buying and selling financial instruments, e.g. brokerage commissions, minimum investment requirements, lawyers fees. Financial intermediaries reduce transactions costs by matching up savers and investors and by capturing economies of scale. Information Costs Information costs are the costs of assessing the credit worthiness of the borrower or monitoring the borrower's actions. Borrowers have better information than lenders about the borrower's prospects and uses of funds (asymmetric information). adverse selection the people most likely to make a claim buy insurance moral hazard insured has less incentive to avoid a loss...
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