information asymmetry


  • An example of adverse selection is when people who are high-risk are more likely to buy insurance because the insurance company cannot effectively discriminate against them,
    usually due to lack of information about the particular individual’s risk but also sometimes by force of law or other constraints.

  • As managers with significant power from information may make decision based on their own interest as opposed to the companies.

  • At the same time, lower-level employees are required to make important decisions with only limited information provided to them.

  • In contract theory and economics, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other.

  • James Fearon in his study of the explanations for war in a game theoretic context notices that war could be a consequence of information asymmetry – two countries will not
    reach a non-violent settlement because they have incentives to distort the amount of military resources they possess.

  • His work with prices as information conveying relative scarcity of goods can be noted as an early form of acknowledging information asymmetry, but with a different name.

  • [21] The idea of information asymmetry has also had a significant effect on management research.

  • [13] 2001 Nobel Prize Inspirations[edit] Information problems have always affected the lives of humans, yet it was not studied with any seriousness until near the 1970s when
    three economists fleshed out models which revolutionized the way we think about information and its interaction with the market.

  • Application in research Accounting and finance[edit] A substantial portion of research in the field of accounting can be framed in terms of information asymmetry, since accounting
    involves the transmission of an enterprise’s information from those who have it to those who need it for decision-making.

  • Alternatively, situations where the buyer usually has better information than the seller include estate sales as specified in a last will and testament, life insurance, or
    sales of old art pieces without a prior professional assessment of their value.

  • [47] • Establish a real-time information announce platform, according to the collect information to achieve market transparency,eliminate trading concerns thereby.

  • The development of contract theory is based on assuming its parties possess different levels of information on the contract’s subject.

  • This idea may be one of the most important in the history and understanding of asymmetric information in economics.

  • In this paper, Akerlof introduced a fundamental concept that certain sellers of used cars have more knowledge than the buyers, and this can lead to what is known as “adverse

  • This cycle repeats until the high-risk policy holders also find similar health policies with cheaper premiums, in which the initial group disappears.

  • An example of monopolies of knowledge is that in some enterprises, only high-level management can fully access the corporate information provided by a third party.

  • [49] Various measures are used to align interest of managers to stop them from abusing their power from information asymmetry such as compensating based on performance using
    a bonus structure.

  • He ultimately concludes that though these economists seemed to have an understanding of the problems of information, they largely did not consider the implications of them,
    and tended to minimize the impact they could have or consider them merely secondary issues.

  • [45] Market impact Zavolokina, Schlegel, and Schwabe (2020) state that Information asymmetry makes buyers and sellers distrust each other, which leads to opportunistic behaviour
    and may even lead to complete break down of the market.

  • It challenges the theorem as one of the key assumptions is that investors would have the same information as a corporation.

  • An example of this could be when a used car is sold, the seller is likely to have a much better understanding of the car’s condition and hence its market value than the buyer,
    who can only estimate the market value based on the information provided by the seller and their own assessment of the vehicle.

  • For instance, when the agent has not gathered information at the outset, does it make a difference whether or not he learns the information later on, before production starts?

  • [46] At the same time, lower quality provision in markets is also one of the consequences, as sellers do not get benefits enough to cover their production costs of providing
    higher quality products.

  • This results in a market failure purely driven by information asymmetry, as under perfect information, all cars can be sold according to their quality.

  • He believes there are two crucial things to consider: first, the incentives, and second, the mechanisms for overcoming information asymmetry.

  • One of those instruments that can be used to reduce the information asymmetry between market participants is intermediary market institutions called counteracting institutions,
    for instance, guarantees for goods.

  • When the level of information asymmetry and associated monitoring cost is high, firms tend to rely less on board monitoring and more on incentive alignment.

  • [54] Contract theory[edit] Contract theory provides insights into how various economic agents can enter contractual arrangements in situation of unequal levels of information.

  • [48] For instance aggressively recognising revenue can result in preparers of financial statements having a much better understanding of the levels of future revenue then
    those reading the statements.

  • Through contract theory, economic agents gain insights on how they can exploit information available to them, to enter beneficial contractua

  • Lastly, mass surveillance helps the political and industrial leaders to amass large volumes of information, which is typically not shared with the rest of society.

  • Information gathering Most models in traditional contract theory assume that asymmetric information is exogenously given.

  • • Enhance customer experience by third-party quality checks like providing expert reviews.

  • According to Arrow, the doctor relies on the social obligation of trust to sell their services to the public, even though the patients do not or cannot inspect the quality
    of a doctor’s work.

  • [24] Monopolies of Knowledge[edit] Main article: monopolies of knowledge In the model of monopolies of knowledge, the ignorant party has no right to access all the critical
    information about a situation for decision-making.

  • Some asymmetric information models can also be used in situations where at least one party can enforce, or effectively retaliate for breaches of, certain parts of an agreement,
    whereas the other(s) cannot.

  • [9] Information asymmetries are studied in the context of principal–agent problems where they are a major cause of misinforming and is essential in every communication process.

  • When buying health insurance, the buyer is not always required to provide full details of future health risks.

  • These mechanisms also let owners of high-quality products get the full value of the goods.

  • He ties it back to the nature of each individual having information that others do not.

  • The study of Mavlanova, Benbunan-Fich and Koufaris (2012) also confirmed that signal usage is different between low-quality and high-quality online sellers.

  • [35][36] Yet, some authors have also studied contract-theoretic models in which asymmetric information arises endogenously because agents decide whether or not to gather information.

  • Private firms have better information than regulators about the actions that they would take in the absence of regulation, and the effectiveness of a regulation may be undermined.

  • This idea was initially studied in the context of matching in the job market.

  • Stiglitz’s work in this area referred to the market for insurance, which is rife with information asymmetry problems to be studied.

  • Regulators can thus take active measures to facilitate the spread of information.

  • [16] Impact of 2001 Nobel Work[edit] These three economists’ simple yet revolutionary work birthed a movement in economics that changed how the field viewed the market forever.

  • Second, Arrow studied the business models of insurance companies and noted that higher-risk individuals are pooled with lower-risk individuals, but both are covered at the
    same cost.

  • [32] Mandatory information disclosure[edit] Both signaling and screening resemble voluntary information disclosure, where the party having more information, for their own
    best interest, use various measures to inform the other party.

  • Blogging on financial websites provides bottom-up communication among investors, analysts, journalists, and academics, as financial blogs help prevent people in charge from
    withholding financial information from their company and the general public.

  • [4] In adverse selection models, the ignorant party lacks of has differing information while negotiating an agreed understanding of or contract to the transaction.

  • Last, he notes how this unique relationship demands that high levels of education and certification be attained by doctors in order to maintain the quality of medical service
    provided by doctors.

  • As a result, many people not willing to risk getting ripped off will avoid certain types of purchases or will not spend as much for a given item.

  • Essentially, this involves the customers returning a defective product regardless of circumstances within a certain time period.

  • Other market mechanisms that help reduce the imbalance in information include brand names, chains and franchising that guarantee the buyer a threshold quality level.

  • George Akerlof’s paper The Market for Lemons[4] introduced a model to help explain a variety of market outcomes when quality is uncertain.

  • [43][44] Sources Information asymmetry within societies can be created and maintained in several ways.

  • Akerlof extends the model to explain other phenomena: Why raising the insurance price cannot facilitate seniors getting medical insurance?

  • believe] about each other’s armaments, quality of military personnel and tactics, determination, geography, political climate, or even just about the relative probability
    of different outcomes” or where they have “incomplete information about the motivations of other agents”.

  • Here each player will have no information of each other’s move while making decisions.

  • [30] Akerlof also suggests different methods with which information asymmetry can be reduced.

  • [50] Effect of blogging[edit] The effect of blogging as a source of information asymmetry as well as a tool reduce asymmetric information has also been well studied.

  • [22] Models Information asymmetry models assume one party possesses some information that other parties have no access to.

  • When the seller has more or better information, the transaction will more likely occur in the seller’s favour (“the balance of power has shifted to the seller”).

  • For instance, in a road construction contract, a civil engineer may have more information on the various inputs required to undertake the project, than the other parties.

  • He noted how other economists have referred to gaining information as a transaction cost.

  • [3] A common way to visualise information asymmetry is with a scale, with one side being the seller and the other the buyer.

  • By providing a guarantee, the buyer in the transaction can use extra time to obtain the same amount of information about the good as the seller before the buyer takes on the
    complete risk of the good being a “lemon”.


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