ACE 474 Exam 2 QUESTIONS CORRECTRY ANSWERED 2026/27

Asymmetric information - CORRECT ANSWER The most basic economic models assume complete information. Consumers and firms know the quality of the goods they buy and sell. In real life, information is often incomplete. Then people have to infer quality from price or other signals. Adverse selection - CORRECT ANSWER Definition: market characteristics leading to more low-quality goods and fewer high-quality goods available; The existence of quality differences is not by itself a market failure; instead, it is a lack of information (incomplete information); Information asymmetries hurt not only those with little information but also those with more information because the lack of complete information prevents trade. Signaling - CORRECT ANSWER When quality in the market is mixed, the bad quality can drive out the good; The result of the incomplete information problem creates an incentive for firms to signal high-quality goods; "Lemons" problem - CORRECT ANSWER Seller has more knowledge regarding true value of the vehicle than the buyer Buyer then does not want to pay more than average price of car, even if it is a "plum" (premium car) Signal example - Education - CORRECT ANSWER Highly productive workers like to let employers know they are indeed highly productive so they might receive a job offer and/or a higher wage. A college degree, however, signals that you are indeed productive Theories that generate overconfidence - CORRECT ANSWER Bias in judgment, Self-image (strategic lying), and signaling Height as a signal - CORRECT ANSWER Taller people earn more, live better lives, and evaluate their lives more favorably on average Signal of cognitive/noncognitive abilities - CORRECT ANSWER Taller children have higher average cognitive and noncognitive test scores Taller children have higher IQ, perform better in school, and are less likely to have behavioral problems Information and attention - CORRECT ANSWER The economic models assume individuals make decisions using all available information. Psychology literature - CORRECT ANSWER People often fail to incorporate all relevant information when they make decisions. Limited attention - CORRECT ANSWER Kahneman and Tversky (1973) pointed out that attention to one task requires a substitution of attention from other tasks; Limited attention is a necessary consequence of cognitive constraints and the vast amount of information available in the environment. The "Friday effect" (DellaVigna and Pollet, 2009) - CORRECT ANSWER Friday announcements have a 15% lower immediate response and a 70% higher delayed response on investments. In addition, trading volume was 8% lower around Friday announcements. Attention-grabbing stocks (Barber and Odean, 2007) - CORRECT ANSWER Individual investors are net buyers of attention-grabbing stocks, e.g., stocks in the news, stocks experiencing high abnormal trading volume, and stocks with extreme one-day returns. Health insurance choice (Handel and Kolstad, 2015) - CORRECT ANSWER Lack of information about available medical providers/treatments, perceived time, and hassle costs for the health plan were important predictors of insurance plan choices and meaningfully impact risk preference estimates. Do experts invest better? - CORRECT ANSWER Empirical evidence suggests that individual investors are more likely to be affected by their limited attention, how about financial experts as analysts and mutual fund managers? They also tend to neglect relevant information (Abarbanell and Bushee, 1997). The authors found that analysts' forecast revisions are inefficient with respect to the future earnings information contained in some of the fundamental signals.