4.4.2 Market Failure In Financial Sector ✅

Question 1

What is market failure?

Answer 1

Free market mechanism fails to allocate resources efficiently leading to suboptimal outcomes for society.

Question 2

Explain the 2009 market failure briefly?

Question 3

What is asymmetric info? Types?

Answer 3

One party had more info than other.
Adverse selection = individuals have hidden info about risks.
Moral hazard = after translation a party behaves differently eg borrowers take on more risk.

Question 4

How is asymmetric info shown in the financial crash? Moral hazard spec?

Answer 4

• Subprime mortgages sold off in CDOs (banks unaware how likely borrowers are to repaying loans).
• Regulators in the financial sector had insufficient information compared to bankers about true level of riskiness.
• banks think they are too big to fail therfore act recklessly knowing the central bank will step in.

Question 5

What are externalities? Relate the financial crash?

Answer 5

Negative spill overs onto 3rd parties.
Financial institutions engaged in risky/excessive lending that can effect entire economy (due to excessive risk). The uk tax payers paid money to rescue banks.
Jobloss + confidence lower (less spending + investment.

Question 6

What is market rigging? Examples?

Answer 6

Manipulation of financial markets to make gains.
- Insider trading (trading based on non-public info).
- 2015 libour manipulation.
-2015 us/uk regulators fined banks 2.6bn for rigging foreign exchange market.

Question 7

What is speculation and market bubbles? Where is the present?

Answer 7

Speculation = buying assets with expectation of profiting from a price increase.
Market bubbles = asset prices rise above actual value due to speculation but this can burst causing market crashes.
GFC housing market believed their prices wouldn’t fall.

Question 8

Explain one cause of market failure in the financial market? (Asymmetric info)

Answer 8