The concept of adverse selection helps to explain
A)why collateral is not a common feature of many debt contracts.
B)why large,well-established corporations find it so difficult to borrow funds in securities markets.
C)why financial markets are among the most heavily regulated sectors of the economy.
D)why stocks are the most important source of external financing for businesses.

Question

Quizplus · Accepted Answer

Adverse selection refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. In the context of financial markets, this can lead to market failure as bad credit risks are more likely to seek loans than good credit risks, prompting lenders to protect themselves. This problem is a key reason financial markets are heavily regulated, to ensure information is disclosed and to protect against market failures caused by information asymmetries.

The Concept of Adverse Selection Helps to Explain