Adverse Selection & Signaling

Adverse Selection & Signaling

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what we will talk about
adverse selection and signaling
one party is less informed, but the actions taken, has a reaction to their lack of information, and they are going to end up with a problem, that they want to avoid

then talk about george ackerloff – neoclassical economist
his model
broad idea: is that in a setting where the projects needing funds for investment are heterogeneous in quality, potential investors may not know a priori much about the quality of an individual project… (Expected mean return from each project)
Used cars market excuse
use the lemon EXAMPLE
lemon model:

Private Information / Adverse Selection / Market Failure:
Adverse Selection

IF quality is private – then you can sell finance, if your’e risk adverse.
Expected utility of what you put in the project, plus a little something
minus the risk premium (cuz you’re risk adverse)

talk about Michael Spence
& Joseph Stiglitz

Signaling – suppose theres not enough risk aversion.
Asking the investor to carry good and bad projects.
Financing everything is pareto efficient then!

Good quality people are going to signal to the investor. If you commit your own money to the project in a sufficient quantity,

It would leave the low quality people projects worst off if they try to emulate themselves as the high quality people
Signaling succeeds, there will be tow market prices for projects

on signaling:

signaling Joseph Stiglitz


**good source: (use wiki references when quoting resources)

connect all the theorists:
good source for that:

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