A market maker buys a block of stock from a hedge fund. Moments later, a negative news story breaks regarding the issuer, and the stock price plummets. The market maker realizes the hedge fund likely traded on this expectation, leaving the market maker with a loss. This scenario best illustrates which type of risk?

Question

Accepted Answer

This is a classic example of adverse selection: the market maker provided liquidity to a trader who had superior (informed) knowledge of an impending event, resulting in the market maker holding a position that immediately lost value.

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