Asymmetric information

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Definition

Asymmetric information or information asymmetry refers to a situation where, of the two (or more parties) to a transaction:

  • One party has access to some information about the transaction that the other party does not have.
  • Both parties (typically) have some prior idea of the fact that the one party has access to the additional information.
  • The party with the additional information does not (usually) have a mechanism to easily share the information with the other party in a manner that the other party is reasonably confident that the information being shared is correct.

Examples

  • Adverse selection: This is a situation where there is a wide range in quality for a good being traded and one party to the transaction has more knowledge of the specific good being traded than the other party. The less knowledgeable party must rely on averages and expected values, while the more knowledgeable party has a better idea of the precise quality.
  • Principal-agent problem
  • Moral hazard can be considered a principal-agent problem variant of adverse selection.