Difference between moral hazard and adverse selection

[kingsly]

Define moral hazard. Explain clearly the difference between moral hazard and adverse selection.

[kingsly]

Moral hazards: – this arises after the transaction has taken place. The lender runs the risk that the borrower may engage in activities that are undesirable from the lender’s point of view because they make it less likely that the loan will be paid back. For example, once borrowers have obtained a loan they may take big risks as they are playing with someone else’s money. As moral hazards lower the probability that the loan will be repaid lenders may decide that they would rather not make the loan.

DIFFERENCE BETWEEN MORAL HAZARD AND ADVERSE SELECTION

The main difference between the two is that adverse selection occurs when there’s lack of symmetric information prior to a transaction/deal between borrower/buyer and lender/seller. Whereas moral hazard occurs when there is asymmetric information between parties after the transaction has taken place.

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