The problem of adverse selection helps to explain
A) why banks prefer to make loans secured by collateral.
B) why banks have a comparative advantage in raising funds for American businesses.
C) why borrowers are willing to offer collateral to secure their promises to repay loans.
D) all of the above.
E) only A and B of the above.

Question

Quizplus · Accepted Answer

Adverse selection refers to the problem where the party in a transaction has information that the other party does not have, leading to potentially risky decisions. This concept explains why banks prefer loans secured by collateral (to mitigate the risk of lending to bad credit risks), why banks have a comparative advantage in raising funds (as they develop expertise in assessing credit risk), and why borrowers offer collateral (to signal their creditworthiness and reduce the interest rate they must pay). Thus, all of the options provided (A, B, and C) are explained by the problem of adverse selection.

The Problem of Adverse Selection Helps to Explain