First watch the following clip (click on the link below) from the movie “Wall St
ID: 1124273 • Letter: F
Question
First watch the following clip (click on the link below) from the movie “Wall Street: Money Never Sleeps (2010)” where Gordon Gekko defines moral hazard as “When someone takes your money and is not responsible for it”.
https://www.youtube.com/watch?v=ydGYzscNpWE&feature=youtu.be
1. I want you to discuss whether Gekko’s definition of moral hazard is a correct. What is Gordon talking about?
2. I want to you give me a definition of Adverse Selection, Gordon Gekko Style. Keep in mind we are having fun here so let us all be creative and maybe it will be used in the third installment of Wall Street.
Explanation / Answer
Answer:- Moral hazard can be defined as lack of incentives to protect against the various consequences for example by insurance.
In other words, it is a situation in which one party gets involved in a risky situation knowingly which is safeguarded against the risk and as a result, it will incur the cost to another party.
So if we look at the above definition the statement given by Gekko seems correct
Adverse selection can be seen as a situation where some specific information is with the sellers and this information are not provided to the customers or vice versa. It can relate to the quality of a product or service.
When we talk about insurance, adverse selection is seen as the tendency of those individuals who are working in the dangerous jobs r high-risk lifestyles and thus opt for life insurance to get some assurance. In order to deal with the issue of adverse selection, most of the insurance firm mainly avoid the exposure to large claims by having the restrictive coverage or increasing the premiums.
Adverse selection can be increased when there is an increase in the securitization. Securitization and the originate-to-distribute business model may make the banks’ incentive unattractive to differentiate between good borrowers and lemon borrowers
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