Chapter 8: Q.15 (page 236)
How do standardized accounting principles help financial markets work more efficiently?
Standardized accounting are standards which make profit verification easier, decreasing adverse selection and moral hazard issues in financial markets and allowing them to function more efficiently.
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You own a house worth $800,000 that is located on a river bank. If the river floods moderately, the house will be completely destroyed. This happens about once every 50 years. If you build a seawall, the river would have to flood heavily to destroy your house, which only happens about once every 200 years. What would be the annual premium for a flood insurance policy that offers full insurance? For a policy that pays only 70% of the home value, what are your expected costs with and without a seawall? Do the different policies provide an incentive to be safer (i.e., to build the seawall) ?
What steps can the government take to reduce asymmetric information problems and help the financial system function more smoothly and efficiently?
How can asymmetric information problems lead to a bank panic?
“The more collateral there is backing a loan, the less the lender has to worry about adverse selection.” Is this statement true, false, or uncertain? Explain your answer.
Which problem of asymmetric information are prospective employers trying to solve when they ask applicants to go through a job interview. Is that the end of the information asymmetry?
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