The role of asymmetric information on investments in emerging markets

Abstract

This paper argues that, because of asymmetric information and adverse selection, forces other than fundamentals may play an immense role in investment flows to emerging markets. When information is distributed asymmetrically between those who make decisions (the government) and the theoretical beneficiaries (investors), optimal investment behaviour is distorted. Information, which is hidden from investors, affects a country adversely, even though it may not be negative in nature. As a consequence of asymmetric information, other more serious problems, which in the long run can prove to be very costly, could appear. The paper applies a model developed by Greenwald and Stiglitz (Asymmetric Information, Corporate Finance, and Investment (1990)) to test for the presence of credit rationing in these markets.