Asymmetric information occurs when one party knows more about an economic transaction or asset than the other party does.

Adverse selection occurs before a transaction takes place. If unmitigated, lenders and insurers will attract the worst risks.

Moral hazard occurs after a transaction takes place. If unmitigated, borrowers and the insured will take advantage of lenders and insurers.

Financial systems help to reduce the problems associated with both adverse selection and moral hazard.

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