Editing Adverse selection (section)

=== Signalling and screening ===
{{main|Signalling (economics)|Screening (economics)}}

In markets where the seller has private information about the product they wish to sell, reputation mechanisms help to reduce adverse selection by acting as a signal of quality.<ref>{{cite journal |last1=Mailath |first1=George J. |last2=Samuelson |first2=Larry |title=Who Wants a Good Reputation? |journal=The Review of Economic Studies |date=2001 |volume=68 |issue=2 |pages=415–441 |doi=10.1111/1467-937X.00175 |jstor=2695935 |url=http://www.ssc.upenn.edu/~gmailath/wpapers/sell-repR2.pdf }}</ref> An example would be the online marketplace, eBay. A seller known for selling high-quality goods can further enhance its reputation by utilizing eBay's [[reputation system]]. There is an incentive for the seller to do so, as buyers who derive utility from purchasing the product are naturally inclined to source their purchase from high-quality sellers. As such, buyers are able to rely on the reputation system as a signal to filter high-quality sellers from low-quality sellers.<ref>{{cite journal |last1=Saeedi |first1=Maryam |title=Reputation and adverse selection: theory and evidence from eBay |journal=The RAND Journal of Economics |date=2019 |volume=50 |issue=4 |pages=822–853 |doi=10.1111/1756-2171.12297 |citeseerx=10.1.1.252.6245 |s2cid=241839161 }}</ref>

Unlike quality signalling where the better informed party acts first, screening is better suited when the uninformed party needs to make the initial decision in participating in a contract.<ref name="Screening, Market Signalling, and C">{{cite journal |last1=Lee |first1=Wayne L. |last2=Thakor |first2=Anjan V. |last3=Vora |first3=Gautam |title=Screening, Market Signalling, and Capital Structure Theory |journal=The Journal of Finance |date=1983 |volume=38 |issue=5 |pages=1507–1518 |doi=10.1111/j.1540-6261.1983.tb03837.x }}</ref> Recognizing that adverse selection stems from the lack of information, using [[screening games]] allows players to try and analyse if the risk of the contract's worst possible outcome makes participating worth it in the first place.<ref name="Screening, Market Signalling, and C"/> Parties can always attempt to be better informed, but if achieving new information is too costly, and the threat of economic loss from the contract is too great, screening methodologies suggest not participating in the contract at all.

For better context using the example of how adverse selection occurs in [[Capital market|financial markets]], if investors believe the risk of poor returns is too high, and the cost of consulting a trading specialist is not worth it, they have screened the possible outcomes and realize it is not worth making that initial investment from the start.<ref name="Screening, Market Signalling, and C"/>