Why do higher interest rates increase adverse selection problems in the loan market?
A)Higher interest rates reduce the gains from economies of scale.
B)As interest rates rise, the creditworthiness of the average loan applicant declines.
C)Higher interest rates reduce information problems in the loan market.
D)At higher interest rates fewer investment projects are profitable.

Question

Quizplus · Accepted Answer

When interest rates rise, it becomes more costly for low-risk borrowers to take out a loan, and thus they are more likely to self-select out of the loan market. Meanwhile, high-risk borrowers, who are willing to pay the higher interest rates, are more likely to apply for loans. As a result, adverse selection problems increase because lenders are more likely to end up with a pool of applicants who are high credit risks.

Why Do Higher Interest Rates Increase Adverse Selection Problems in the Loan