how to minimize adverse selection
both sellers and buyers can reduce adverse selection by increasing access to information thus minimizing asymmetries for consumers the internet has greatly increased access while reducing costs crowd sourced information in the form of user reviews along with more formal reviews by bloggers or specialist websites are often free and warn potential buyers about otherwise obscure issues around quality warranties and guarantees offered by sellers can also help allowing consumers to use a product risk free for a certain period to see if it has flaws or quality issues and to return them without consequence if any arise laws and regulations can also help such as lemon laws in the used car industry federal regulatory authorities such as the food and drug administration fda also help ensure that products are safe and effective for consumers insurers reduce adverse selection by requesting medical information from applicants in the form of requiring paramedical examinations querying doctors offices for medical records and looking at one s family history this gives the insurance company more information that an applicant may fail to disclose on their own moral hazard vs adverse selectionmoral hazard is the risk that one party has not entered into a contract in good faith or has previously provided false details about its assets liabilities or credit capacity like adverse selection moral hazard occurs when there is asymmetric information between two parties however adverse selection occurs when there s a lack of symmetric information prior to a deal between a buyer and a seller and moral hazard occurs after a deal is struck for instance in the investment banking sector it may become known that government regulatory bodies will bail out failing banks as a result bank employees may take on excessive amounts of risk to score lucrative bonuses knowing that if their risky bets do not pan out the bank will be saved anyhow the lemons problemthe lemons problem refers to issues that arise regarding the value of an investment or product due to asymmetric information possessed by the buyer and the seller the lemons problem was put forward in a research paper the market for lemons quality uncertainty and the market mechanism written in the late 1960s by george a akerlof an economist and professor at the university of california berkeley 1 the tag phrase identifying the problem came from the example of used cars akerlof used to illustrate the concept of asymmetric information as defective used cars are commonly referred to as lemons the takeaway is that due to adverse selection the only used cars left on the market will ultimately be lemons the lemons problem exists in the marketplace for both consumer and business products and also in the arena of investing related to the disparity in the perceived value of an investment between buyers and sellers the lemons problem is also prevalent in financial sector areas including insurance and credit markets for example in the realm of corporate finance a lender has asymmetrical and less than ideal information regarding the actual creditworthiness of a borrower 