Generative AI and Information Asymmetry: Impacts on Adverse Selection and Moral Hazard

Abstract

Information asymmetry often leads to adverse selection and moral hazard in economic markets, causing inefficiencies and welfare losses. Traditional methods to address these issues, such as signaling and screening, are frequently insufficient. This research investigates how Generative Artificial Intelligence (AI) can create detailed informational signals that help principals better understand agents' types and monitor their actions. By incorporating these AI-generated signals into a principal-agent model, the study aims to reduce inefficiencies and improve contract designs. Through theoretical analysis and simulations, we demonstrate that Generative AI can effectively mitigate adverse selection and moral hazard, resulting in more efficient market outcomes and increased social welfare. Additionally, the findings offer practical insights for policymakers and industry stakeholders on the responsible implementation of Generative AI solutions to enhance market performance.