Question

Why are financial markets observers concerned about "moral hazards"?

Answer 1

Moral hazard arises in financial markets when one party knows that there is impending risk and gets into a risky transaction in the financial market by knowing that the cost is being transferred to the counter-party who is unaware of the risk. The moral hazard arises due to lack of complete information among the parties to a transaction. This can lead to total failure of the financial markets. For example, you know of an impending fall of prices on a particular stock and get into transactions that can make you huge profits with others who still do not have this information is financially fraudulent. This is a result asymmetric information among market participants.