Final answer:
Many firms transfer insurable risk to capital markets through the securitization of risk. this process turns risks into securities that investors can buy, as seen in the securitization of mortgages. imperfect information affects these transactions where better-informed firm insiders sell risk to less-informed investors.
Step-by-step explanation:
When many firms choose to transfer insurable risk to the capital markets, they often do so through the creation of a financial instrument. this process is known as the securitization of risk. it allows firms to transform the financial flows associated with potential losses from risks into securities that investors can purchase. One of the most well-known examples of this practice is the securitization of mortgage risk, where financial companies create pools of mortgages, turn them into financial securities known as mortgage-backed securities and then sell them to investors. in essence by securitizing the loans, lenders shift the mortgage risks to the investors, who in turn rely on rating agencies to evaluate the credit risk of these securities.
However, it should be noted that the existence of imperfect information plays a significant role in financial transactions. Those running a firm typically have more knowledge about a firm's potential for future profits than outside investors. as a result, investors must rely on various mechanisms, such as rating agencies, to assess risk, which may not always be accurate, as seen in the leniency of ratings before the financial crisis.