DEFINITION of 'Lemon'

A lemon is a very disappointing investment in which your expected return is not even close to being achieved, and more than likely ends up costing you some or all of the capital committed. Lemon investments can be associated with poor money management, economic factors, financial fraud or just plain bad luck.

BREAKING DOWN 'Lemon'

The most common and well-known example of a lemon is in the used car industry, where defective or poorly conditioned vehicles are bought and sold by the purchaser without prior knowledge of the true state of the vehicle. For example, a car might be sold with mechanical issues that are so costly to repair, the price to fix the vehicle eclipses the sale price and value of the car. Moreover, a vehicle might be sold with irreparable maintenance issues that will likely render it inert and unusable shortly after the purchase.

Comparable issues, in a figurative sense, can occur with other types of investments. Homes may have hidden damages and defects that can vacate the perceived market value. Infrastructure work, such as pipe replacement, foundation repairs, or extensive removal of mold, can escalate the costs of the residence beyond the means of the buyer, making it unlikely for them to effect the upgrades and fixes. That, in turn, can make it unlikely that the buyer will be able to resell the house at a price that would allow them to realize any value from the overall transaction.

Consumers have some recourse in these instances. Regulations in the United States, for example, offer some protections to consumers in the event they purchase a defective vehicle, known as lemon laws. When a person buys or sells a lemon, he may be at a disadvantage if he does not have the same information necessary to make an informed decision as the other party to the transaction. This information asymmetry is sometimes called the lemons problem, a term coined in the 1970s by economist George Akerlof.

What Are Lemon Investments?

In investing, the lemons problem commonly arises in the areas of insurance and corporate finance, most notably in investment banking. For example, many entities lost substantial sums of money in the wake of the 2008 U.S. financial crisis, after purchasing mortgage-backed securities derived from mortgages that were rated low risk when the risks were actually substantial. In many cases, individuals working for investment banks possessed information indicating the risks were high, but the buyers of the these banks' products lacked the same information.

RELATED TERMS
  1. Lemon Laws

    Lemon laws are a form of consumer protection; they provide legal ...
  2. Lemons Problem

    The lemons problem is an issue of information asymmetry between ...
  3. Plum

    A plum investment is a choice investment, or one that has outperformed ...
  4. Insurance Fraud

    Insurance fraud is executing illicit schemes to falsely reap ...
  5. House Poor

    House poor is a situation that describes a person who spends ...
  6. Asymmetric Information

    Asymmetric information occurs when one party to a transaction ...
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. Personal Finance

    Used Car Shopping: How to Avoid a Lemon

    Being prepared before buying will save you thousands in the long run.
  3. Insurance

    How Car Insurance Companies Value Cars

    Learn the methodology used by car insurance companies to value cars, and understand why the amount they give you may not cover the cost of a similar vehicle.
  4. Trading

    5 Ways To Get Top Dollar For Your Used Car

    Unlike the housing market, the used car market is a seller's market. Here's how to get your car ready for an unbelievable offer.
  5. Insights

    5 Nobel Prize-Winning Economic Theories You Should Know About

    Here are 5 prize-winning economic theories that you’ll want to be familiar with.
  6. Personal Finance

    The Complete Guide to Buying a Used Car

    Everything you need to know to buy a reliable used car for a good price.
RELATED FAQS
  1. 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 >>
Trading Center