Which of the following best illustrates adverse selection?
A)A person adds risky stock to their portfolio.
B)A person who has narrowly avoided many accidents applies for automobile insurance.
C)A person is unwilling to buy a stock when she believes its price has an equal chance of rising or falling $10.
D)A person gets homeowners insurance and then checks their smoke detector batteries less frequently.

Question

Quizplus · Accepted Answer

Adverse selection refers to a situation in which one party in a transaction has more information than the other party, and uses that information to their advantage, resulting in a less desirable outcome for the less informed party. In this case, the person who narrowly avoided many accidents likely knows that they are at a higher risk of getting into an accident than the average driver, and is therefore more likely to apply for automobile insurance. This could result in the insurance company facing a higher risk of having to pay out claims, which could lead to higher premiums for everyone.

Which of the Following Best Illustrates Adverse Selection