Word
Adverse selection
Adverse selection occurs when one side knows more about risk than the other. The people or assets most likely to cause a loss enter the deal, while safer participants stay away.
Examples
When lenders cannot tell safe borrowers from likely defaulters, they charge one high rate. Safer borrowers walk away; riskier ones still accept.
In a funding panic, the banks most eager to borrow may be those hiding the largest losses, so lenders pull back from everyone.
Origin
The term began in insurance: people who know they face greater risk are more likely to buy coverage when insurers cannot price them separately. Economists later generalized the pattern to credit, labor, and financial markets.
How it connects
The insurance industry's old name for the pattern that can freeze a funding market.
This word appeared in What hidden knowledge does to markets, the Involves connection for July 30, 2026, which asked: How did one hedge fund make the world's largest banks afraid to trade?
Check yourself
Which situation is adverse selection?
Lenders charge one high rate because they cannot tell safe borrowers from likely defaulters, so safer borrowers walk away.. Right. The selection happens before the deal closes: hidden risk shows up disproportionately, and safer participants leave.
What the sources establish
Adverse selection arises when asymmetric information lets the more informed side select into or out of transactions, degrading the pool the less informed side faces.
Sources
The Market for “Lemons”: Quality Uncertainty and the Market Mechanism (George A. Akerlof, 1970), Pages 488–500; the automobiles example and insurance application