Adverse Selection & Signaling
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
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
Private Information / Adverse Selection / Market Failure:
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: https://www.ppge.ufrgs.br/giacomo/arquivos/ecop26/davis.pdf
signaling Joseph Stiglitz
also talk about PRINCIPLE AGENT PROBLEM) A SYMMETRIC
https://en.wikipedia.org/wiki/Information_asymmetry (use wiki references when quoting resources)
connect all the theorists:
good source for that: https://online.sfsu.edu/mbar/ECON605/presentations/ASS1.pdf