Fixed: Why Personal Finance is Broken and How to Make it Work for Everyone
by John Y. Campbell and Tarun Ramadorai · 25 Jul 2025
the premiums the company receives from the insured population will not be enough to cover the payouts they have to make. This problem, known as adverse selection, leads insurance companies to restrict the amount of insurance people can buy. One way of offering only partial insurance is to put a cap on
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. They will also be saddled with disproportionately higher premiums, because their choice of coverage informs the insurance company about their risks through the channels of adverse selection and moral hazard. As mentioned earlier, the right level of coverage will make the proportional loss of wealth if an emergency occurs (scaled up or
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healthy on average, but loses money in later years, as the same policyholders get older and sicker. This helps to protect the insurance company against adverse selection, since even relatively healthy policyholders have a good deal in the later years and thus have an incentive to keep paying their premiums. The problem
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other drivers and other vehicles (“third party” coverage). We are not opposed to mandatory insurance in principle. It has the important advantage that it eliminates adverse selection by forcing everyone, not just the people who face the greatest risks, to buy insurance. However, a problem arises when mandatory insurance is bundled into
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bequest be larger if they die young and smaller if they die old.28 Annuities also have substantial markups.29 Insurance companies are concerned about adverse selection, fearing that it will mostly be people in relatively good health who buy annuities.30 Beyond this, they worry that the risk of dying at
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and income lost to disability and to people in good health who fear outliving their retirement savings. Such a combined policy mitigates the risk of adverse selection and can therefore be offered at lower cost than the separate components. While we have warned that bundling financial products is often a way to
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financial markets can function poorly even when market participants are rational and financially sophisticated. They discuss externalities, public goods, market power, and the problems of adverse selection and moral hazard created by asymmetric information; but, like this book, they stress the impact of financial mistakes on financial outcomes. Campbell et al., “Consumer
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insurance, as in the best-case scenario, you pay premiums and the risk that you are insuring against does not materialize. 39. See Benjamin Handel, “Adverse selection and inertia in health insurance markets: When nudging hurts,” American Economic Review 103 (2013): 2643–2682; Saurabh Bhargava, George Loewenstein, and Justin Sydnor, “Choose to
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light on this motivation. 29. Mitchell et al., “New evidence on the money’s worth of individual annuities.” 30. Amy Finkelstein and James M. Poterba, “Adverse selection in insurance markets: Policyholder evidence from the UK annuity market,” Journal of Political Economy 112 (2004): 183–208. 31. Thomas Davidoff, Jeffrey R. Brown, and
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of, 136–137 actuarial fairness, 140–141, 294–295n32 adjustable-rate mortgages (ARMs), 116–118, 229; funding sources for, 234, 289n37; in starter kit, 247 adverse selection, insurance and, 141–142 Affordable Care Act (2010), 316n27 African Americans: appeal of cryptocurrencies for, 192–194; Freedman’s Savings Bank collapse and, 193, 277n32
Trading and Exchanges: Market Microstructure for Practitioners
by Larry Harris · 2 Jan 2003 · 1,164pp · 309,327 words
the wrong side of the market. If prices change before they can restore their original positions, they will lose money. Economists call this risk adverse selection risk. Adverse selection risk is the most important cause of ex post regret. Limit order traders can minimize the risk of ex post regret by placing their orders
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price changes are independent of their inventory imbalances, the risk is a diversifiable inventory risk. If they are inversely correlated, the risk is an adverse selection risk. 13.7.1 Diversifiable Inventory Risk Diversifiable inventory risks are due to events that cause price changes no one can predict. Such price changes
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are sometimes positive and sometimes negative. On average, they are zero. Otherwise, they would be predictable. Diversifiable inventory risks are benign compared to adverse selection risk. Although dealers lose when prices unexpectedly move against their positions, they gain when prices unexpectedly move in their favor. Since the price changes are
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one security. Firms often deal in hundreds or thousands of instruments in order to diversify their exposure to diversifiable inventory risks. 13.7.2 Adverse Selection Risk Dealers face adverse selection risk when they trade with informed traders. This risk is not benign. Dealers—like all traders—lose money when they trade with better
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dealer inventories fall short of their targets, and prices subsequently rise. When informed traders sell, dealer inventories exceed their targets, and prices rise. Dealers avoid adverse selection risk only by avoiding informed traders. The best way they can avoid informed traders is to set their quotes near fundamental values so that informed
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values and avoid substantial losses. Dealers generally discover fundamental values as a by-product of their search for market values. 13.8 DEALER RESPONSES TO ADVERSE SELECTION Successful dealers must confront the informed trader problem continuously. They must respond appropriately when they suspect that they have traded with an informed trader.
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publicly available fundamental information is scarce or highly ambiguous. Such instruments are hard to value and often are highly volatile. 13.8.3 The Adverse Selection Spread Component Dealers do not simply adjust their quotes after they believe that they have traded with an informed trader. Before they set their quotation
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thus is not attractive to well-informed traders who trade on material information that will soon become public. Time Slicing allows Madoff to control the adverse selection problem that all dealers face. By refusing to offer immediate liquidity to well-informed traders, Madoff can offer more liquidity to uninformed traders. Source:
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trader is likely to be trading on material information, their ask prices will be substantially greater than their bid prices. The dealers’ response to adverse selection makes trading large orders very expensive. Dealers generally believe that traders with large orders tend to be well informed. They believe this because well-informed
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substantially when they believe that traders have split large orders into small pieces to obtain better prices. The price adjustments that dealers make to avoid adverse selection cause large orders to have substantial market impact. The substantial impacts that large anonymous orders have on price make it very difficult to trade
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that dealers receive are not balanced, dealer inventory imbalances become inversely correlated with future price changes, and dealers thereby lose money. Dealers avoid these adverse selection losses by setting their bid and offer prices so that they surround their best estimates of fundamental values. They estimate values by using all information
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market values. • The inferences dealers make about future order flows create a spread between their bid and ask prices. This spread is called the adverse selection spread component. • The adverse selection spread component increases with trade size. 13.15 QUESTIONS FOR THOUGHT • Which traders do you expect are more risk averse, dealers or brokers
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an information perspective. Here we examine it from an accounting perspective. Remarkably, although the two perspectives are quite different, they both imply the same size adverse selection spread component. The two components taken together constitute the total spread. Dealers never quote both components separately. They simply quote their bid and ask prices
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component are permanent in the sense that they do not systematically reverse. Subsequent price increases and decreases are equally likely. Price changes due to the adverse selection spread component reflect changes in dealers’ estimates of instrument values. When dealers efficiently use all information available to them to estimate values, the resulting sequence
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permanent in the sense that it affects the levels of all subsequent values of the random walk. 14.2.3 Two Explanations for the Adverse Selection Component The adverse selection spread component has two aspects. From an information perspective (see chapter 13), it is the difference in the value estimates that dealers make
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result, known as the Glosten-Milgrom theorem, appears in the appendix to this chapter. You can easily understand the result by considering what determines the adverse selection component from both perspectives. To simplify our discussion, assume that dealers know exactly what values are if informed traders are trading. (Our result does
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of the pricing error (assuming that the trader is informed) times the probability of trading with an informed trader. From the accounting perspective, the adverse selection spread component is the amount that dealers should charge all their clients to recover their losses to informed traders. In our simple analysis, assume the
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two components give prices different statistical properties. The transaction cost spread component causes prices to bounce back and forth between bid and offer prices. The adverse selection spread component causes unpredictable price changes that have the properties of a random walk. In both cases, the price changes depend on whether a
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why uninformed traders lose to informed traders, regardless of whether they trade with limit or market orders. In both cases, they suffer the effects of adverse selection. When uninformed traders use limit orders, their orders fill quickly if they overprice their bids or underprice their offers. Informed traders then eagerly trade
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future price changes correctly, prices often will move away from the limit orders, and the uninformed traders will regret not trading. In this case, adverse selection causes uninformed traders to lose profitable trading opportunities. Uninformed traders thus often regret using limit orders. When they trade with informed traders, they regret trading
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expensive than market order strategies for uninformed traders. Equilibrium spreads therefore must widen to compensate. The additional widening of the bid/ask spread is the adverse selection spread we discussed earlier. For most securities and contracts, the degree of information asymmetry varies inversely with how well traders estimate values. When most traders
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will be wide. Wide spreads, however, discourage uninformed investors, decrease trading volumes (a secondary spread determinant), and thereby make spreads even wider. Asymmetric Information The adverse selection spread model suggests that markets with asymmetrically informed traders will have wide spreads. Spreads will be widest when well-informed traders know material information about
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volatile instruments than for stable instruments. Volatility therefore has a strong secondary effect on spreads because it is a good proxy for asymmetric information. The adverse selection spread component generally will be large for volatile instruments. Utilitarian Trading Interest Utilitarian traders—primarily investors, borrowers, hedgers, asset exchangers, and gamblers—trade because
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tend to have narrow bid/ask spreads. Second, since utilitarian traders are uninformed, they dilute information in the order flow when they trade. The adverse selection spread component therefore will be small when utilitarian trading interest is strong. Since we discussed above how asymmetric information affects bid/ask spreads, we now
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quickly lay off inventory imbalances. Since they can more easily control their inventories in active markets, they face less inventory risk—diversifiable inventory risk and adverse selection risk. They therefore can quote smaller spreads for actively traded instruments than they can for infrequently traded instruments. Public traders who are committed to trading
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will be wider for new firms than for old firms. Insider-trading Rules Markets that effectively enforce insider-trading rules protect their liquidity suppliers from adverse selection. Insider-trading rules prevent traders from trading on certain types of material information. Bid/ask spreads will be smaller when such insiders cannot trade.
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• Dealer spreads depend on their costs. • Informed trading makes spreads wide. • Uninformed traders indirectly lose to informed traders when they pay spreads made wide by adverse selection. • Spreads are small in active markets for well-known assets. • Large anonymous traders are widely thought to be well informed. • Limit order traders give away
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his best estimate of the security value is V − P · E. The difference between these two values, 2 · P · E, is the adverse selection spread component. The derivation of the adverse selection spread from the accounting perspective estimates the spread the dealer must quote to ensure that he expects to just break even, ignoring
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do, they demand very large price concessions. Block liquidity suppliers demand these price concessions for the same reasons that dealer bid/ask spreads include an adverse selection component. These price concessions allow liquidity suppliers to recover from uninformed traders what they lose to informed traders. They also reflect the inferences about fundamental
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better-informed traders have. When they suffer the winner’s curse, they have mistakenly valued their instruments. 16.2.1.1 The Adverse Selection Risk Value traders are subject to adverse selection risk because they offer liquidity in response to other traders who demand it. They must be particularly careful that they do not
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in fact are overvalued or undervalued. They eventually lose when prices move against their positions as traders learn the new information. Value traders respond to adverse selection risk just as dealers do. They widen their spreads to recover from uninformed traders what they lose to better-informed traders. Equivalently, they widen
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they ultimately offer liquidity are uninformed. Since these research activities are expensive, outside spreads must be larger than dealer spreads. In contrast, dealers control their adverse selection exposure by adjusting prices to find market values, by avoiding well-informed traders, and by refusing to take large inventory positions. Since value traders speculate
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information may arrive that changes values. Such changes make their positions risky. If the new information is inversely correlated with their positions, they have suffered adverse selection from news traders. If the new information is uncorrelated with their positions, it will be diversifiable. In either event, value traders must trade at
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to do so. Unless compelled to provide liquidity, dealers provide liquidity only to the extent that they feel comfortable. If they face too much adverse selection from informed traders, no amount of capital will make them willing to supply liquidity. Capital adequacy regulations therefore only ensure that dealers can offer liquidity
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to price reversals. 20.6 QUESTIONS FOR THOUGHT • What are the relations among liquidity, transaction costs, and transitory volatility? • To which volatility components do the adverse selection and transaction cost spread components contribute? • To which volatility component do the price impacts of news traders contribute? To which volatility component do the price
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permanent price effect is due to inferences that dealers (and other liquidity suppliers) make about informed traders from the order flow. It corresponds to the adverse selection spread component introduced in chapter 13. Information theoretic considerations suggest that the permanent effect should be proportional to trade size. (See chapters 12 and
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will not execute. However, if prices move toward them, they will quickly execute, and the traders who submitted these limit orders will regret trading. Adverse selection hurts these traders by reducing their opportunities to profit from trades that are followed by price changes which benefit their positions. Dealers and public limit
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spreads and thereby increases transaction costs for uninformed market order traders. (Chapters 13 and 14 explain how dealers and limit order traders respond to the adverse selection due to informed traders.) Insider trading also increases transaction costs for uninformed limit order traders. Like dealers, limit order traders lose when they trade
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F. M. Osborne. 1966. Market making and reversal on the stock exchange. Journal of the American Statistical Association 61(316), 897–916. Sandås, Patrik. 2001. Adverse selection and competitive market making: Empirical evidence from a limit order market. Review of Financial Studies 14(3), 705–734. Silber, William L. 1984. Marketmaker behavior
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firm, 360 active manager, 197, 442, 443, 458, 487–88 actual shipper, 352, 353 ADRs. See American depository receipts adverse selection, 287–91, 303 adverse selection loss, 286 adverse selection risk, 77, 135, 286, 340–41 adverse selection spread component, 289–90, 299, 300–302, 320–21 affirmative determination, 155 after-hours trading session, 92 afternoon session, 92
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offer, 70, 217 Betreuers, 495 betting, 91 bid, 69, 125 bid/ask bounce, 299, 413, 432 bid/ask spread, 71, 93, 297–321 adverse selection and uninformed traders, 303 adverse selection component, 289–90, 299–302 cross-sectional predictions, 311–17 dealer, 297–98, 313, 519 definition of, 70, 280 equilibrium spreads in continuous
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451 prediction problem, 450–52 statistical evaluation, 452–71 unforseeable factors, 443–44 perishable goods, 412, 416 permanent price effect, 435 permanent spread component. See adverse selection spread component Perold’s implementation shortfall, 424 Persian Gulf, 352 peso problem, 468 Pfizer (co.), 228 Philadelphia Stock Exchange, 589 physically convened markets, 90 physically
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uniform pricing rule, 120–25, 129–30 unilateral search, 395–96 uninformed liquidity demanders, 339–40, 373, 376 uninformed traders, 6, 237–38, 241 and adverse selection, 303, 304 and asymmetric information, 531 and block trading, 327, 331 and dealers, 291, 292 definition of, 177 and fundamental values, 239 reasons for
Big Data and the Welfare State: How the Information Revolution Threatens Social Solidarity
by Torben Iversen and Philipp Rehm · 18 May 2022
prices and pushes out good risks and that, in turn, increases prices even further in a spiraling logic. In the insurance literature, this is called adverse selection. Adverse selection is not the only 1 https://doi.org/10.1017/9781009151405.001 Published online by Cambridge University Press 2 Introduction reason insurance markets break down
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good and bad risks, it must charge similar premiums for everyone. But these premiums are “too high” for good risks, and this leads to adverse selection: with these relatively high premiums, insurance is only attractive to bad drivers, leaving the company with only high-risk customers. For insurance markets to survive
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these programs are known as “social insurance,” or “the welfare state.” Like all insurance, these programs are affected by asymmetric information problems. Governments can avoid adverse selection by compelling (i.e., forcing) every citizen to be part of the insurance program. Moreover, premiums are tied to income (which governments can observe), not
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. Otherwise, they will attract high-risk types, who drive up insurance premiums and push low-risk types out of the pool. The result of such “adverse selection” is the eventual breakdown of insurance markets, or the emergence of what Akerlof (1970) called a market for lemons (where the “lemons” are a
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the common private solution to the rising demand for both credit and social insurance, yet they failed everywhere. They clearly illustrate the difficulty of overcoming adverse selection problems, as well as the closely related problems of intergenerational transfers. Such transfers were required to address major issues of poverty and illness in
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greater today than it was in the past. We see this both in the rise of supplementary private insurance, which is subject to the same adverse selection problems as other types of health insurance, and in the increased segmentation of both private and public provision. But the picture is more complex
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.org/10.1017/9781009151405.002 Published online by Cambridge University Press 30 Theoretical Framework types, and the price will increase accordingly. This is the adverse selection and will lead to more opt-outs until the marginal utility of having at least some insurance outweighs the cost. The poor may or may
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often think of as fundamental to social insurance. However, it involves a challenging time-inconsistency problem, which can be understood as a special case of adverse selection but is better treated as a separate problem. This timeinconsistency problem is not part of standard insurance models, including the one presented previously. When
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insurance to be effective, the insurance component needs to be much larger than the savings component, and then plans run into the double issue of adverse selection and time inconsistency. Most health problems tend to be concentrated at the end of life, but compared to life insurance, the risks are much
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but they may not be permitted to use it. In this case, the analysis is indistinguishable from the asymmetric information case in Figure 2.1: adverse selection will undermine markets. One example is the US Genetic Information Nondiscrimination Act of 2008 (GINA), which prohibits health insurers from using individuals’ genetic information to
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– the segmentation logic of markets may arise in the public sector. appendices Appendix 2.1: Graphical Representation of the Pooled Equilibrium with Private Information and Adverse Selection In Figure 2A.1, there are three risk groups: L, M, and H. With no insurance, income is y in the good state and
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is constant across individuals. 13 Published online by Cambridge University Press 30 Theoretical Framework types, and the price will increase accordingly. This is the adverse selection and will lead to more opt-outs until the marginal utility of having at least some insurance outweighs the cost. The poor may or may
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often think of as fundamental to social insurance. However, it involves a challenging time-inconsistency problem, which can be understood as a special case of adverse selection but is better treated as a separate problem. This timeinconsistency problem is not part of standard insurance models, including the one presented previously. When
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insurance to be effective, the insurance component needs to be much larger than the savings component, and then plans run into the double issue of adverse selection and time inconsistency. Most health problems tend to be concentrated at the end of life, but compared to life insurance, the risks are much
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but they may not be permitted to use it. In this case, the analysis is indistinguishable from the asymmetric information case in Figure 2.1: adverse selection will undermine markets. One example is the US Genetic Information Nondiscrimination Act of 2008 (GINA), which prohibits health insurers from using individuals’ genetic information to
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– the segmentation logic of markets may arise in the public sector. appendices Appendix 2.1: Graphical Representation of the Pooled Equilibrium with Private Information and Adverse Selection In Figure 2A.1, there are three risk groups: L, M, and H. With no insurance, income is y in the good state and
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is constant across individuals. 13 Published online by Cambridge University Press 30 Theoretical Framework types, and the price will increase accordingly. This is the adverse selection and will lead to more opt-outs until the marginal utility of having at least some insurance outweighs the cost. The poor may or may
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often think of as fundamental to social insurance. However, it involves a challenging time-inconsistency problem, which can be understood as a special case of adverse selection but is better treated as a separate problem. This timeinconsistency problem is not part of standard insurance models, including the one presented previously. When
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insurance to be effective, the insurance component needs to be much larger than the savings component, and then plans run into the double issue of adverse selection and time inconsistency. Most health problems tend to be concentrated at the end of life, but compared to life insurance, the risks are much
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but they may not be permitted to use it. In this case, the analysis is indistinguishable from the asymmetric information case in Figure 2.1: adverse selection will undermine markets. One example is the US Genetic Information Nondiscrimination Act of 2008 (GINA), which prohibits health insurers from using individuals’ genetic information to
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– the segmentation logic of markets may arise in the public sector. appendices Appendix 2.1: Graphical Representation of the Pooled Equilibrium with Private Information and Adverse Selection In Figure 2A.1, there are three risk groups: L, M, and H. With no insurance, income is y in the good state and
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life expectancies, but also that outsiders had no feasible way of gaining access to the group’s life insurance benefits. In other words, the adverse selection was not a concern. In addition, the fund was built up gradually and resembled fully funded retirement schemes in the sense that most collected benefits
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, the funds would go bankrupt, which created an incentive not to join and pay dues in the first place. Indeed, if the solution to adverse selection was to seek a more homogenous membership, this only made the problem of correlated risks more severe. Unlike life insurance, all unemployment insurance was organized
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). In this respect, MASs had a real advantage over commercial insurance, which was anonymous and arm’s length. Nevertheless, it was hard to avoid adverse selection in the case of sickness pay, and the time-inconsistency problem was never far behind because older workers were more likely to fall sick or
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have accidents. Unlike the case of burial insurance, rising life expectancy made the adverse selection problem worse (Beito 1990, 725), and the implied direct transfer between younger and older generations was severe enough that it has been likened to
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exclude bad risks, they faced increased competition for good risks from commercial insurance companies. Life insurance provides an early example. While MASs sought to limit adverse selection by religion, ethnicity, or occupation, modern life insurance companies were based on actuarial science and modern underwriting principles, notably the requirement of a medical
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Some MASs tried to offer their own group-based policies, but since membership was voluntary and not tied to employment, they immediately encountered problems of adverse selection. MASs were essentially eliminated from the health insurance market by 1940 (Beito 2000, chapter 11). The MAS double bind of having to exclude bad
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of the former uninsured – a trend only recently counteracted by the ACA. 3 Gottlieb (2007) claims that MASs providing sickness insurance did not face an adverse selection problem. But the evidence is not entirely persuasive. He essentially tests whether members (compared to nonmembers) were more likely to be sick (or suffer
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an accident). According to his data, this does not appear to be the case, but membership composition already reflects efforts to deal with adverse selection. In our view, the adverse selection was in fact a serious problem for MASs. https://doi.org/10.1017/9781009151405.003 Published online by Cambridge University Press Before the
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highlighted the limitations of private solutions, whether in the form of MASs or commercial businesses, in responding to the rising demand for social insurance. Adverse selection and time inconsistency loom large in this account, and together they set the stage for a revolutionary shift toward a public system that pooled risks
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fund, and it often did just that in the case of unemployment MASs (until such insurance was abandoned altogether). Second, even in stable environments, adverse selection would often either deter membership among good risks and/or leave a large number of workers uninsured. The state solved these problems by compelling workers
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of poverty and disease among the old and infirm. Only the emerging modern democratic states had the capacity to address these challenges. Governments could overcome adverse selection by mandating the take-up of insurance. Such mandatory risk pooling did not come about for efficiency reasons – as economists tend to imply – but
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undesirable applicants and to charge appropriate premiums, based on an applicant’s assessed mortality risk. In the language of our theoretical framework, information mitigates the adverse selection problem and helps companies set actuarially fair premiums. As shown in Figure 2.2, customers are placed into risk groups and charged different premiums,
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low, symmetric information to high, symmetric information when it is not common knowledge that information is low. In this scenario, insurers will worry about adverse selection and raise premiums accordingly, limiting the scope of markets. Without common knowledge, insurers are essentially operating in a risky environment and therefore demanding a risk
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Markets 83 calculate the insurance premium, it is therefore essential that they are able to accurately calculate the life expectancy of potential policyholders. The adverse selection problem is obvious in this context because people will buy plans that assume they will live longer than they themselves expect to live. The first
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regulation of the life insurance industry, a typical restriction is that insurance companies cannot use genetic information to set premiums. This in turn creates an adverse selection problem for insurers. The quantitative results are clearly only suggestive – we do not claim to have identified causal effects – but they lend credence to
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case in point. Profits in the life insurance business depend on making accurate predictions about life expectancy, but life insurance faces the same problem of adverse selection as other insurance markets. The first life insurance company evolved out of a mutual aid society that provided Scottish presbyterian ministers with widows insurance.
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a title-granting graduate-level seminary education in theology, and no one became a seminarian just to get access to insurance. This effective gatekeeping eliminated adverse selection. Commercial insurers cannot use such exclusionary criteria to select their customers, but they can increasingly distinguish groups of potential buyers with different risk profiles
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profitmaximizing private firms to reach more than a small segment of potential buyers without the help of major public subsidies. As in the lowinformation case, adverse selection will be a problem that deters good risks from joining insurance plans. In terms of tax policy, if the state declines to accommodate private
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companies: Their risk classification would be excellent; they could identify bad risks with high accuracy; and they would not need to worry as much about adverse selection. But “reversed asymmetric information” – for lack of a better term – is not a case we cover in our theoretical models. It might become one
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COVID-19 pandemic, 61, 74, 77, 86n20, 100, 189 credible information, 28, 38, 39 credit guarantee schemes (CGSs), 115 credit markets: access to, 105–106; adverse selection and, 112; banks and, 105 (see also banks); collective bargaining and, 64, 159, 193; default and, 108–120, 128, 131–136, 141–146, 196–
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France, 80, 90, 102, 107, 147 fraternal sciences, 47, 52 Freddie Mac, 65, 109, 116–130, 140n25, 197 Friedman, Rachel, 15n1, 19, 191 funded systems: adverse selection and, 45; information and, 18; intergenerational transfers and, 7; pension systems, 7, 17, 33, 53, 55, 58, 64, 193, 201; retirement and, 16, 33,
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legal issues: clerical marriage, 44; discrimination, 116; intergenerational contracts and, 31; social media, 81; symmetric information and, 26 Lexis Nexis Risk Classifier, 76 life expectancy: adverse selection and, 45; historical perspective on, 45, 48–51; increased data on, 10, 45; predicting, 18, 193; premiums and, 17; private markets and, 72, 83
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102, 107 Norway, 90, 92, 102, 107, 147 Obama, Barack, 76, 81, 90 occupational unemployment rates (OURs), 174n0 OECD Health Statistics, 89, 101 opting out: adverse selection and, 30, 54, 199; Akerlof and, 24; Bismarckian system and, 53; cost of, 19, 29; deterrents against, 9; private markets and, 25; privileged, 15;
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24–25, 29–30, 37, 41 Oscar Health Insurance, 80 Palme, Joakim, 53, 193 Park, Sunggeun (Ethan), 99 participation, 9, 67, 95, 102, 184 partisanship: adverse selection and, 37; coercion and, 6; Comparative Political Data Set and, 102; credit markets and, 118; historical perspective on, 59; labor markets and, 177, 183; preferences
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196, 198; tax, 19, 50, 63, 115, 195, 199; trackers and, 80–81; welfare and, 37–38 Reinfeldt, Fredrick, 92, 177 Republican Party, 94 retirement: adverse selection and, 45; Employee Retirement Income Security Act and, 50n2, 60–61; funded systems and, 16, 33, 45, 64, 96; individual retirement accounts (IRAs), 47, 64
High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems
by Irene Aldridge · 1 Dec 2009 · 354pp · 26,550 words
maker to other market participants. This chapter describes information-based microstructure trading strategies. MEASURES OF ASYMMETRIC INFORMATION Asymmetric information present in the markets leads to adverse selection, or the ability of informed traders to “pick off” uninformed market participants. According to Dennis and Weston (2001) and Odders-White and Ready (2006), the
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of asymmetric information have been proposed over the years: r r r r r Quoted bid-ask spread Effective bid-ask spread Information-based impact Adverse-selection components of the bid-ask spread Probability of informed trading Quoted Bid-Ask Spread The quoted bid-ask spread is the crudest, yet most readily
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time t − 1 to time t. Brennan and Subrahmanyam (1996) propose five lags in estimation of equation (1): K = M = 5. Adverse Selection Components of the Bid-Ask Spread The adverse selection components of the bid-ask spread is attributable to Glosten and Harris (1988). The model separates the bid-ask spread into the
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following three components: r Adverse selection risk r Order-processing costs r Inventory risk Models in a similar spirit were proposed by Roll (1984); Stoll (1989); and George, Kaul, and Nimalendran
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to time t, Si,t is the effective bid-ask spread as defined previously, and λi is the fraction of the traded spread due to adverse selection. Probability of Informed Trading Easley, Kiefer, O’Hara, and Paperman (1996) propose a model to distill the likelihood of informed trading from sequential quote data
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. Ask t Mid t Bid t * Time Sell FIGURE 11.2 Inventory costs. Askt Mid t Bid t * Time Sell FIGURE 11.3 Asymmetric information (adverse selection). Trading on Market Microstructure 151 order. If bid-ask spreads were to compensate the dealer for the risks associated with holding excess inventory, then any
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foreign exchange prices differs from the process of other asset classes, say equities. Traditional microstructure theory observes four components contributing to the bid-ask spread: adverse selection, inventory risk, operating costs, and occasional monopoly power. Foreign exchange literature often excludes the possibility of monopolistic pricing in the foreign exchange markets due to
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decentralization of competitive foreign exchange dealers. Some literature suggests that most bid-ask spreads arise as a function of adverse selection; dealers charge the bid-ask spread to neutralize the effects of losing trades in which the counterparties are better informed than the dealer himself. As
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Monetary Fund Working Paper. 92/61. Samuelson, Paul, 1965. “Proof that Properly Anticipated Prices Fluctuate Randomly.” Industrial Management Review 6, 41–49. Sandas, P., 2001. “Adverse Selection and Competitive Market Making: Empirical Evidence from a Limit Order Market.” Review of Financial Studies 14, 705–734. Savor, Pavel and Mungo Wilson, 2008. “Asset
India's Long Road
by Vijay Joshi · 21 Feb 2017
for risk-sharing via health insurance. But unregulated markets in health insurance are notoriously subject to market failure. One of the causes is so-called ‘adverse selection’. There is a tendency for unhealthy people to demand more health insurance relative to healthy people, which bids up the average premium. This reinforces the
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of health trouble or excluding certain services from coverage, with the consequence that many people are left uncovered by health insurance. In the presence of ‘adverse selection’, the government can improve overall welfare by universal compulsory health insurance. (Equity considerations can be handled by state subsidies to pay the insurance premiums of
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providers to supply, unnecessary care and more expensive care, which leads to cost and price escalation. Moral hazard cannot be addressed by state intervention. But adverse selection constitutes by itself a sufficient ground for the state to step in and regulate the insurance market. Countries differ in their response to market failures
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the government should insure poor people and gather them in a single risk pool, with enrolment that is available independently of health status (to prevent adverse selection). This will guard against the scandal of exclusion from insurance that has plagued the United States. At the same time, it is also right to
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(i.e. hospital) care, there is a powerful market- failure case for state intervention to make health insurance compulsory for everyone in order to avoid ‘adverse selection’, which leads to many people being uncovered by insurance (as in the United States, until the Obama reform). There is also a powerful equity case
Expected Returns: An Investor's Guide to Harvesting Market Rewards
by Antti Ilmanen · 4 Apr 2011 · 1,088pp · 228,743 words
. Asymmetric information refers to situations in which one party is better informed than the other, leading to so-called principal–agent problems (including moral hazard, adverse selection, conflict of interest). Vayanos–Woolley (2010) show that delegated asset management can cause momentum patterns. As investors (principals) try to learn about a manager’s
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“index”. Investable indices offered lower costs, better transparency, and better liquidity than non-index investments. However, top HFs had little incentive to participate, leading to adverse selection bias, and investable HF indices have consistently underperformed broader HF indices. After a brief detour I will return to other HF alternatives. Alphas, betas, alternative
Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor
by John Kay · 24 May 2004 · 436pp · 76 words
reducing their costs, markets in risk concentrated them and made them threatening, even fatal, to the solvency of participants. { 238} John Kay Asymmetric Information and Adverse Selection * ••••••••• * ••••••••••••••••••••••••• * The risk that Seabiscuit will not come in first in the 1940 Santa Anita handicap. The risk that the Federal Reserve will unexpectedly lower interest
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. Couples visiting their insurance broker will be as representative of the whole population as couples visiting the marriage guidance counselor. This is the problem of adverse selection: the people who want the policy are bad risks. A "fair" premium based on the average incidence of divorce would be unprofitable for the insurance
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expectancy. Inexpensive and noninvasive tests of height, weight, and blood pressure can give the insurer equivalent knowledge about the prospective policyholder's health. Even so, adverse selection is a problem. Medical insurance is cheaper when bought by an employer for a group of workers. This is not primarily because of the employer
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's greater bargaining power. The insurer insists that the employer provide cover for all employees and so reduces or eliminates the adverse-selection issue. Private individuals seeking medical insurance are more than averagely likely to be sick, or to be hypochondriacs. Markets for life and medical insurance are
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problem it raises for insurance markets cannot be solved by limiting the use of genetic information by insurers. That would only aggravate the issue of adverse selection. The only solution to the potential information asymmetry is to stop such information being collected at all-which would be impossible even if it were
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gains. When those you insure can influence the risks you cover, you must supervise them. Social Insurance of Personal Risks ••••••••••••••••••••••••••••••••••••• When people can opt out, adverse selection is a problem. If you can't easily watch what they're doing, moral hazard is a problem. The combination of
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adverse selection and moral hazard means that risks are best managed by groups that have other common bonds: typically families, communities, workplaces, and nations. The management of
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, too, shifted from communities to employers. Employers are far less vulnerable to moral hazard than either private insurers or the state, and the issue of adverse selection does not arise. An employee of a bank or a large diversified corporation could assume that, absent misconduct, there would always be a job, and
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employees. This organized mutual sharing of risks is today part of the economic structure of most West European states. Government is well-placed to reduce adverse selection, because it can compel participation, but is less effective at reducing moral hazard than the social pressures of a local community. Formal social insurance schemes
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but badly. Private markets fail to provide effective protection against the principal risks of life-accidents, redundancy and unemployment, and relationship breakdown. Moral hazard and adverse selection are widespread. We are bad at assessing risks and calculating probabilities. The major risks of life cannot be handled by markets. 2 The policy choices
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are not actuarially matched to expected costs. Social insurance expresses social solidarity. Membership cannot be optional, because that leads to free riding, moral hazard, and adverse selection. But solidaristic institutions need not, and should not, only be agencies of the state. Large companies are the most efficient providers of unemployment and work
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(2000). This is the undiversifiable risk for which the equity risk premium is the reward. Arrown (1971) is a seminal discussion of moral hazard and adverse selection. The proportion of single women in the u.s.n who are mothers doubled between 1970 and 2000. Adams (1995), 12-13. Barth (1991), White
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, 214,347 mechanisms of, 216-17,255 and rationality, 217-21,229,231,347-48 and self-interest, 217,252,256,343 See also cooperation adverse selection, 238-42, 349 advertising, 225-27, 229, 255 Africa, 281,282-84 agriculture, 77, 81, 84 central planning, 105-6, 112-13 development of, 54
The Third Pillar: How Markets and the State Leave the Community Behind
by Raghuram Rajan · 26 Feb 2019 · 596pp · 163,682 words
others to sign up for insurance plans. The proponents of Obamacare thought that compulsion would reduce overall health insurance premiums by reducing the extent of adverse selection (the phenomenon where the healthiest young people do not sign on because they least need health care). The angry Tea Party opponents instead felt they
Money Free and Unfree
by George A. Selgin · 14 Jun 2017 · 454pp · 134,482 words
event of any single counterparty’s failure. A simple way to accomplish that end, while further limiting the Fed’s risk exposure and guarding against adverse selection, would be to open participation to any financial institution with a CAMEL score of 1 or 2.7 Such a broadening of Fed counterparties would
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have to decide what security types are eligible, favoring those for which holdings are sufficiently dispersed to provide for competitive bidding, and (to further discourage adverse selection) indicating maximum values of total and individual security purchases that it is prepared to make from a single participant.18 The list of such securities
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assure this outcome and, thereby, make a single set of open market rules suffice to consistently conform to Bagehot’s rule—while still guarding against adverse selection—the Fed need only take care to set sufficiently low reference prices.19 These prescriptions, taken together, might be summarized by paraphrasing Bagehot as follows
Principles of Corporate Finance
by Richard A. Brealey, Stewart C. Myers and Franklin Allen · 15 Feb 2014
Alessandro Lizzeri argue that this may help to explain the prevalence of car leasing. See I. Hendel and A. Lizzeri, “The Role of Leasing under Adverse Selection,” Journal of Political Economy 110 (February 2002), pp. 113–143. Thomas Gilligan uses a similar argument to analyze the market for aircraft leasing. See T
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environmental damage can eat up millions of dollars in legal fees. Insurance companies need to recognize these costs when they set their premiums. • Reason 2: Adverse selection. Suppose that an insurer offers life insurance policies with “no medical exam needed, no questions asked.” There are no prizes for guessing who will be
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most tempted to buy this insurance. Our example is an extreme case of the problem of adverse selection. Unless the insurance company can distinguish between good and bad risks, the latter will always be most eager to take out insurance. Insurers increase premiums
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be less careful to take proper precautions against damage. Insurance companies are aware of this and factor it into their pricing. The extreme forms of adverse selection and moral hazard (like the fire in the farmer’s barn) are rarely encountered in professional corporate finance. But these problems arise in more subtle
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paying for engineering studies or for a program to monitor maintenance. All these costs are rolled into the insurance premium. When the costs of administration, adverse selection, and moral hazard are small, insurance may be close to a zero-NPV transaction. When they are large, insurance is a costly way to protect
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pool risks by holding a diversified portfolio of policies. Insurance works less well when policies are taken up by companies that are most at risk (adverse selection) or when the insured company is tempted to skip on maintenance or safety procedures (moral hazard). Firms can also hedge with options and with forward
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(APV) Net present value of an asset if financed solely by equity plus the present value of any financing side effects. ADR American depository receipt. Adverse selection A situation in which a pricing policy causes only the less desirable customers to do business, e.g., a rise in insurance prices that leads
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–651 review of, 500–501 value of interest tax shields, 500–501 Adler, B. E., 857 Administrative costs in leasing, 641 in pooling risks, 663 Adverse selection risk, 663 Agency costs, 12 Agency for International Development, 794n Agency problem, 295–314, 862–863, 882–883 agents versus principals, 12 compensation plans, 295
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