Adverse Selection

Economists George Akerlof, Michael Spence, and Joseph Stiglitz were jointly awarded the 2001 Nobel Prize in Economic Sciences for their pioneering studies of asymmetric information and its impact on economic activity. Two well-known types of information asymmetries are (1) hidden actions and (2) hidden information. Hidden actions can give rise to “moral hazard,” which is discussed in a separate entry in this encyclopedia. Hidden information can give rise to “adverse selection,” on which this entry focuses. Both of these aspects of asymmetric information need not imply deliberate, ethical breaches or misconduct. In many situations, information asymmetries and their associated costs are normal by-products of a market economy in which different economic actors are merely behaving in a manner consistent with their incentives, given the information ...