Adverse selection is a problem associated with equity and debt contracts arising from ________.
A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities
B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults
C) the borrower's lack of incentive to seek a loan for highly risky investments
D) the lender's inability to restrict the borrower from changing his behavior once given a loan

Question

Quizplus · Accepted Answer

Adverse selection arises when the lender lacks information about the borrower's potential returns and risks of his investment activities. This can occur when the borrower has private information that is not disclosed to the lender, leading the lender to assume greater risk than anticipated.

Adverse Selection Is a Problem Associated with Equity and Debt