The Dirty Little Secret of Finance: Asymmetric Information
Asymmetric information is present in almost all transactions that happen on a daily basis, whether it be at a lemon stand, or through buying stocks. Asymmetric information is whenever one party in an economic transaction possesses greater material knowledge than the other party; whether it be the seller or the buyer. An example of asymmetric information is the sale of a used-car; the seller possesses much more information about the car and its history than the potential buyers. However, most of the time there is a method to resolve the information gap. For example, if you don’t trust the used-car salesman about the quality of the car, you can have it checked out by a mechanic. In finance, these tools are often much less reliable than for cars and other products. For example, when stocks are traded, asymmetric information is very present as the seller and buyer know much less than the actual company whose stock is being traded. Ideally, there shouldn’t be much trading in the stock market at all, as buyers/sellers should not feel comfortable with the company having a great deal more information than the parties involved in the transaction. However, due to the irrational nature of people, this is not the case as large amounts of trading occurs on a daily basis.
Why is asymmetric information important to understanding financial markets? The reason people want cars, houses, food, etc. is because those items are useful immediately, whereas people who buy and sell financial assets have no desire for the asset itself, but instead they care about the future value of the asset. Therefore, this means that while information for items, such as the used-car, is very important, when it comes to financial markets, the information is the product. In conclusion, this signifies that in financial markets, having knowledge about the asset is extremely crucial and is much more important (and dangerous for that matter) than asymmetrical information about other household items.
https://www.bloomberg.com/view/articles/2016-08-11/the-dirty-little-secret-of-finance-asymmetric-information