Asymmetric information

In forex markets and financial markets, one party often does not know enough about the other party to make accurate decisions. This inequality is called asymmetric information. Lack of information creates problem: adverse selection and moral hazard. Adverse selection is the problem before the transaction occurs. It occurs when the potential borrowers who are the most likely to produce an undesirable outcome- the bad credit risks—are the ones who most actively seek out a loan and are thus most likely to be selected.

Moral hazard is the problem after the transaction occurs. It is the risk that the borrower might engage in activities that are undesirable from the lender’s point of view because they make it less likely that loan will be paid back. Because moral hazard lowers the probability that the loan will be repaid, lenders may decide that they would rather not make a loan.