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Information Asymmetry and Moral Hazard in Financial Economics

One of the most important neoclassical economic theory assumption is the perfect information. It assumes complete knowledge of required information for acting in the market, especially of other party's motives. However, whenever two individuals interact in reality, complete knowledge of the other party’s motives and thoughts is simply impossible. Information asymmetry is an extremely important issue in the fields of consumer behavior, insurance, agency theory and bank loans. For the information to be of real value it must reduce the uncertainty of the parties involved. Adverse selection can emerge if the agent holds private information before the relationship is begun. Moral hazard occurs at a point in time later in the relationship where asymmetric information is due to the lack of verifiable action on the side of the agent or if he obtains new information. This paper shows models of adverse selection and moral hazard, with their application areas. One method that could reduce information asymmetry and, in this way, decrease the costs of bad decision making is the signaling, also shown in this paper

adverse selection, agency theory, information asymmetry, moral hazard, signaling

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