Loading the player...

What is 'Asymmetric Information'

Asymmetric information, sometimes referred to as information failure, is present whenever one party to an economic transaction possesses greater material knowledge than the other party. This normally manifests itself when the seller of a good or service has greater knowledge than the buyer, although the opposite is possible. Almost all economic transactions involve information asymmetries.

BREAKING DOWN 'Asymmetric Information'

Asymmetric information is the specialization and division of knowledge in society as applied to economic trade. For example, medical doctors tend to know more about medical treatment than their patients; after all, those doctors specialize in medicine, while their patients do not. The same principle applies to manufacturers, teachers, police officers, attorneys, restaurant operators and yoga instructors, or any other specialized profession.

Economic Advantages

Growing asymmetrical information is a desirable outcome of a market economy. As workers specialize and become more productive in their fields of expertise, they can provide greater levels of value to workers in other fields. For example, a stockbroker’s services are less valuable to customers who already know enough to buy and sell their own stocks with confidence.

One alternative to ever-expanding asymmetric information is for workers to study in all fields, rather than specializing in those fields where they can provide the most value. This comes with large opportunity costs and would likely result in a lower level of aggregate output, lowering standards of living.

Another alternative is to make information abundantly and cheaply available, such as through the internet. This does not replace asymmetric information, however. It only has the effect of moving information asymmetries away from simpler areas and into more complex areas.

Possible Problems

In certain circumstances, asymmetric information may lead to adverse selection or moral hazard. These are situations where individual economic decisions are hypothetically worse than they would have been had all parties possessed more symmetrical information. Most of the time, the solutions to adverse selection and moral hazard are not complicated.

Consider adverse selection in life insurance or fire insurance. Higher-risk insurance customers, such as smokers, the elderly or those living in dry environments, may be more likely to purchase insurance. This could raise insurance premiums for all customers, forcing the healthiest to drop out. The solution is to perform actuarial work and insurance screening, then charge different premiums to different customers based on potential risk.

Information Asymmetry in Finance

Information asymmetries tend to be greatest in those areas where information is complex, difficult to obtain or both. For instance, it is relatively difficult to obtain large information asymmetries when trading baseball cards, but it is relatively easier in fields such as law, medicine, technology or finance.

To prevent abuse of customers or clients by specialists, financial markets often rely on reputation mechanisms. Financial advisors and fund companies that prove to be the most honest and effective stewards of their clients' assets tend to gain clients, while dishonest or ineffective agents tend to lose clients or face legal damages.

RELATED TERMS
  1. Contract Theory

    The study of how individuals and businesses construct and develop ...
  2. Adverse Selection

    1. The tendency of those in dangerous jobs or high risk lifestyles ...
  3. Asymmetric Volatility Phenomenon ...

    The asymmetric volatility phenomenon (sometimes known as AVP) ...
  4. Asymmetrical Distribution

    A situation in which the values of variables occur at irregular ...
  5. Lemons Problem

    The issue of information asymmetry between the buyer and seller ...
  6. Moral Hazard

    The risk that a party to a transaction has not entered into the ...
Related Articles
  1. Managing Wealth

    How To Avoid Buying A "Lemon" Product

    A lack of information can lead people into bad purchases and bad investments. Find out how you can avoid these lemons.
  2. Insurance

    Examples of Adverse Selection in the Insurance Industry

    Find out what the term "adverse selection" refers to in the insurance industry, and learn how insurance companies protect themselves from adverse selection.
  3. Small Business

    Moral Hazards: A Bump In The Contract Road

    Learn how this phenomenon can cause a party in an agreement to behave differently than expected.
  4. Small Business

    What is a Moral Hazard?

    The risk that a party to a transaction has not entered into the contract in good faith, or has provided misleading information.
  5. Insurance

    What is Adverse Selection in the Insurance Industry?

    Adverse selection impacts the markets for health insurance and automobile insurance, but interfering with actuarial work has consequences.
  6. Investing

    Investment Services Stump Investors

    What you're getting isn't easy to determine. Find out how to get your money's worth.
  7. Financial Advisor

    Asset Manager Ethics: Rules Governing Capital Markets

    The integrity of the capital markets needs to be kept at utmost importance for all investors. This article shows how to maintain the integrity while investing.
  8. Financial Advisor

    Why Financial Advisors Sell Life Insurance

    Life insurance has a part in almost any serious financial plan, and a financial advisor can both advise and sell policies as part of an overall strategy.
  9. Insurance

    Exploring Advanced Insurance Contract Fundamentals

    Understanding your contract can help you protect our family's financial security.
RELATED FAQS
  1. How do financial market exhibit asymmetric information?

    Understand how financial markets exhibit asymmetric information. Learn how asymmetric information by any party can result ... Read Answer >>
  2. How significant is asymmetric information risk?

    Learn about the presence of asymmetric information risk in the financial markets and how various parties present or are exposed ... Read Answer >>
  3. Do any markets not exhibit asymmetric information?

    Find out why every market possesses information asymmetry, and why this isn't necessarily a huge or insurmountable problem ... Read Answer >>
  4. How can the problem of asymmetric information be overcome?

    Find out how market actors deal with the problem of asymmetric information, particularly when it leads to possible adverse ... Read Answer >>
  5. What is the theory of asymmetric information in economics?

    Read a brief overview of asymmetric information theory in economics, the development of its main arguments and why some challenge ... Read Answer >>
  6. What is the difference between adverse selection and moral hazard?

    Learn about the differences between adverse selection and moral hazard in economics, and how blocking price signals causes ... Read Answer >>
Hot Definitions
  1. Money Market

    A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. ...
  2. Block (Bitcoin Block)

    Blocks are files where data pertaining to the Bitcoin network is permanently recorded.
  3. Fintech

    Fintech is a portmanteau of financial technology that describes an emerging financial services sector in the 21st century.
  4. Ex-Dividend

    A classification of trading shares when a declared dividend belongs to the seller rather than the buyer. A stock will be ...
  5. Debt Security

    Any debt instrument that can be bought or sold between two parties and has basic terms defined, such as notional amount (amount ...
  6. Taxable Income

    Taxable income is described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments ...
Trading Center