Editing Adverse selection (section)

== Moral hazard ==
{{main|Moral hazard}}

A related form of [[market failure]] is [[moral hazard]]. With moral hazard, the asymmetric information between the parties causes one party to increase their risk exposure ''after'' the transaction is concluded, whereas adverse selection occurs ''before''. Moral hazard suggests that customers who have insurance may be more likely to behave recklessly than those who do not. Adverse selection, on the other hand, suggests that customers will withhold information about existing health conditions from the health insurer when purchasing insurance.

 {| class="wikitable"
|+ Adverse selection vs moral hazard
! Major differences
! Adverse selection
! Moral hazard
|-
! Asymmetric information regarding the
| type of individual || behaviour of an individual
|-
! That causes a bias
| before entering a contract
| after entering a contract
|}

Realistic scenarios that actively involve both economic phenomena would include the market for rental properties.<ref>{{cite journal |last1=Benjamin |first1=John D. |last2=Lusht |first2=Kenneth M. |last3=Shilling |first3=James D. |title=What Do Rental Contracts Reveal About Adverse Selection and Moral Hazard in Rental Housing Markets? |journal=Real Estate Economics |date=1998 |volume=26 |issue=2 |pages=309–329 |doi=10.1111/1540-6229.00747 }}</ref> Adverse selection occurs in the process of deciding ''before'' renting or buying a property (''the contract''). Those who are uncommitted to doing the regular upkeep of the house due to time constraints, are ill-prepared to compensate for damages, or just innately irresponsible, are more likely to rent. In contrast to a person who is interested in buying, they would be less willing to maintain a property in good condition for the long-term. These ''types'' of renters would then take advantage of the asymmetric information between the landlord, who would ideally want to lease the property to tenants ''without'' these characteristics. Moral hazards takes place ''after'' the contract. Tenants are more likely to change their behaviour after moving in, as there are less incentives to be good tenants since the property is not theirs and they can leave as soon as their lease ends. This would mean less inclination to maintain good upkeep, or being liable for anything the landlord should be responsible for. Both adverse selection and moral hazard is at play here, but occur at different points in time and are due to asymmetric information regarding different factors. In the latter case, however, it could be argued that there is no real issue of asymmetric information at play, given that the source of the behaviour change is a particular incentive structure which all parties are aware of.

===Adverse selection in game theory===

The crisis of various financial markets makes people pay more and more attention to the [[market analysis]] of markets with adverse selection, especially the credit market and insurance market. Most of the current market analysis on competitive equilibrium market with adverse selection is based on the research results of Rothschild and Stiglitz (1976). We can also add adverse selection to a broad form of competitive market games. It allows companies to offer any limited contract, as well as a price differential subsidy. At the same time, the company pulled out of the market after initial contract offers were observed. In such cases, Netzer, Nick and Florian (2014) proved that perfect equilibrium in subgames always exists. When the withdrawal is costless, the set of equilibrium outcomes may correspond to the entire set of feasible contracts. We then focus on robust equilibria that continue to exist for small withdrawal costs. Netzer, Nick and Florian (2014) suggested that the Miyazaki—Wilson contracts are the unique, robust equilibrium outcome in this case.

===Adverse selection in business===

In business dealings, buyers and sellers often encounter information asymmetry. For example, manufacturers may generally be more accurate than suppliers in predicting demand for their products. Another example is the acquisition of a company in which senior management of the target company has a deeper understanding of the information and value of the company's intangible assets than the acquirer. However, most of the theoretical research on the contract between buyer and seller assumes that private information is unverifiable. Therefore, informed buyers can make arbitrary claims about subjective information parameters. Patrick (2014){{cn|date=November 2024}} believes that private information is verifiable in practice.

===Adverse selection and collateral in lending market===

In accordance with the research from Loannidou, Pavanini & Peng in April 2022, the adverse selection theory also plays a significant role in determining the lending market performance based on the incremental costs of collateral and debt contracts. 

While the recent research also pointed out that, in separation of ex ante and ex post channels of collateral, the increasing level of adverse selection moral problem is having significant effects on bond markets and lenders' spirit. While the empirical evidences and statistical model both suggested that, the utilization of collateral could reduce the negative effect of adverse selection. In practice, through the promotion of information sharing system and credit rating mechanism, it is expected that, within the lending market regulations on collateral contact, the relevant stakeholder could have better incentives and techniques to reduce the social welfare cost that is cause by adverse selection. 

By including a separate borrower, there is sufficient evidence to conclude that, under the diversification lending strategy, the implementation of collateral could effectively mitigate the adverse selection issues, and adjust the borrower's financial behaviour into a positive direction. 

===Adverse selection with asymmetric information in the mortgage market===

In the acquisition of commercial mortgages between the sellers and borrowers, the adverse selection problem will appear corresponding with the phenomenon of asymmetric information. In case of CMBS, An, Deng & Gabriel (2010) pointed out that, due to the unequal information on the secondary market loans, it reinforce the conduit on lenders about the mortgage quality and information. The investors on mortgage market will effectively consider the effect of adverse selection, which correspondingly lead to a lower price margin on loans and portfolios in the market. To sum up, although the agency problem does not appears in junk loans and bonds, it still add the dissatisfied opinion on investor's behaviours.