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February 3, 2014

Middlemen Margins and Information Asymmetry

For markets to work perfectly well, symmetric information has to be incorporated. In this situation, the producers and consumers are enlightened about the products. On the contrary, asymmetric information refers to the situation whereby one of the parties’ to a particular transaction bears more superior information opposed to the other party. Mostly, the situation happens in transactions where the seller portrays more information than the buyer. However, the reverse may as well occur. Potentially, the situation can be dangerous as one of the party’s in a contract may resolve to take advantage over the other. The scope of asymmetrical information has been significantly reduced by the advancements in technological developments whereby every all the people are facilitated to achieve all types of information regarding to contracts. Asymmetric information can bright about two drastic consequences. Firstly, it reflects to the adverse selection whereby immoral behavior can take advantage of the asymmetric information before the transaction. Moral hazard behavior may take advantage of the asymmetrical information (Landa 24). Therefore, this essay discusses the role of asymmetrical information on the formation of financial intermediaries and or the efficiency of financial markets.
Asymmetric information poses great problems to the financial markets. The sectors that are greatly affected by asymmetric information include lending and borrowing. In these financial markets, the borrower manifests better information relating to his financial position than the lender does. It is rather difficult for the lender to discern whether the borrower will default the payment. To overcome the information inadequacy, the lender always tries to look into the past credit records of the borrower. However, the information the lender obtains is significantly low to ascertain the exact financial position of the borrower (Rausser, Simon & Zhao 52). The existence of financial intermediaries can be attributed to their capacities to moribund costs that emanate from transaction and information between lenders and borrowers in the marketplace. Therefore, financial intermediaries become handy in leveraging proper functioning of a market, and any other aspect that affect the level of credit that is channeled through these intermediaries can have profound effect to the macroeconomics of any firm. Asymmetry of information is an issue that not only affects lenders, but also borrowers. The problem can lead to a moral hazard, which come into play when a borrower engages in acts that can increase the chances of a credit beyond being defaulted.
An intricate financial system involves both the financial markets as well as the financial intermediaries. We differentiate financial intermediaries regarding to whether they subject complete reliant contracts or partial contracts. Intermediaries like banks that offer imperfect contracts e.g., demand deposits, are subject to runs; however, this may not suggest a market breakdown. A complicated financial system bears complete markets for comprehensive risks and narrow participation in the market. It is only efficient when the intermediaries avail complete conditional contracts, or else controlled -efficient, when the intermediaries offer incomplete contracts. We dispute that there may be a responsibility for adaptable liquidity portrayed by the economy in which markets for cumulative perils are incomplete.
Asymmetrical information facilitates the availability of public credit rating among the financial markets. This happens when an independent credit agency conducts an evaluating report on the borrower’s credit worthiness then the presence of the estimate is anticipated to be associated with lower asymmetry of information (Herrera 467). Also, asymmetrical information is involved as an additional measure that is associated with the amount as well as the quality of information that is presented regarding the borrower. Information asymmetries tend to be more severe on huge loans. This happens because any fixed costs involved while obtaining information with regards to the borrower acts as less of an obstacle for the huge loans (Evans 12). Asymmetrical information plays a significant role in the reputation of the arranger of syndication. In addressing the arranger’s dominant task in resolving the information, asymmetry in a syndicated loan market, the analysis has to engage the reputation of a facility arranger who is syndicated. The significance of the arranger’s reputation is motivated by the empirical evidence that other more reputable arranger’s may syndicate the loans.
Asymmetrical information plays a significant role in creating trust among companies, individuals and the lenders. In this regard, the system can be applied to solve the uncertainty puzzles portrayed by the lending institutions.

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