Business Case Studies & Business Publications

Adverse Selection in Businesses

Sun, Bo

Technical Note

Adverse Selection in Businesses

Sun, Bo

GEM-0248 | Published June 23, 2025 | 3 Pages Technical Note

Collection: Darden School of Business

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Adverse selection is a concept in economics and finance that arises from information asymmetry between parties involved in a transaction. It occurs when one party has more or better information than the other, leading to a selection process that favors those with hidden—and often unfavorable—characteristics. For instance, in the insurance market, individuals who know they are high risk are more likely to purchase insurance, while those who are low risk may opt out if premiums are set based on average risk. This can result in a disproportionate number of high-risk individuals in the insured pool, driving up costs and potentially causing market failure. Adverse selection is highly relevant in a wide range of business contexts because it can arise in any economic transaction wherein one party has more information about their own risk profile or quality than the other party has. This primer explores its origins, implications, and mitigation strategies across various business contexts.