What is Adverse Selection? Adverse selection refers to a scenario where either the buyer or the seller has information about an aspect of product quality that the other party does not have. Adverse selection is a common scenario in the insurance sector, where people in high-risk lifestyles or those engaged in dangerous jobs sign up…
What is Normal Distribution? The normal distribution is also referred to as the Gaussian or Gauss distribution. The distribution is widely used in natural and social sciences. It is made relevant by the Central Limit Theorem, which states that the averages obtained from independent, identically distributed random variables tend to form normal distributions, regardless of…
What are Point Estimators? Point estimators are functions that are used to find an approximate value of a population parameter from random samples of the population. They use the sample data of a population to calculate a point estimate or a statistic that serves as the best estimate of an unknown parameter of a population….
Prospect Theory, introduced by psychologists Daniel Kahneman and Amos Tversky in 1979, explores decision-making under risk and uncertainty. It is a psychology theory that suggests that individuals prioritize avoiding losses over seeking gains, exhibiting characteristics like certainty preference, discounting small probabilities, relative positioning, and loss aversion. The theory involves two phases: editing (framing effects) and…
What is Screening? Screening refers to a strategy that is used to combat adverse selection by filtering out false information and retaining only the true information. Screening is used in contemporary markets where the products being released into the market are getting increasingly complex for an ordinary consumer to comprehend. For example, in the auto…
What is Binomial Distribution? Binomial distribution is a common probability distribution that models the probability of obtaining one of two outcomes under a given number of parameters. It summarizes the number of trials when each trial has the same chance of attaining one specific outcome. The value of a binomial is obtained by multiplying the…
What is the Manufacturer’s Suggested Retail Price (MSRP)? The manufacturer’s suggested retail price (MSRP) is the price at which the manufacturer recommends retailers sell its product. The MSRP generally reflects all the manufacturing and selling costs associated with a product. It is also known as the list price, or the recommended retail price (RRP), or the…
What is Clustering Illusion? Clustering illusion refers to a cognitive bias in behavioral finance in which an investor observes patterns in what are actually random events. In other words, clustering illusion bias is the bias that arises from seeing a trend in random events that occur in clusters that are actually random events. The clustering…
What is a Vickrey Auction? A Vickrey auction is a sealed-bid auction where bidders submit bids without knowing the bids of other people. However, as opposed to other sealed-bid auctions, the price paid is the second-highest bid price and not the winning bid price. The Vickrey auction was named after William Vickrey, a Canadian who…
