Why is adverse selection more likely in financial markets when interest rates rise?
A)The remaining borrowers are more likely to be risky.
B)Higher interest rates are likely to hurt the economy.
C)If firms have to pay higher interest rates, they may choose to use the funds differently than they first intended.
D)Banks eliminate risky borrowers by raising interest rates.

Question

Quizplus · Accepted Answer

When interest rates rise, people who are the least risky tend to refinance their debt, while risky people are unable to obtain credit. As a result, only the most risky borrowers remain in the market, increasing the likelihood of adverse selection.

Why Is Adverse Selection More Likely in Financial Markets When