What is 'Adverse Selection'?

What is 'Adverse Selection'?

Approach: Describe an information asymmetry where one party has more information than the other.

In finance, it refers to a situation where a market maker trades against someone with superior information, leading to losses. It is often called 'toxic flow' in high-frequency trading.

Follow-up: How do market makers adjust spreads to account for this?

Key concepts: information asymmetry, toxic flow.