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The Winner's Curse

The document discusses the winner's curse, where the winning bid in an auction exceeds the intrinsic value of the item. It notes that rational theories assume all bidders know the value, but aggressive bidding and many bidders can cause overpayment. The winner's curse is more likely with more bidders and aggressive bidding, as the winner may pay over 25% above the true value.

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Das Randhir
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143 views1 page

The Winner's Curse

The document discusses the winner's curse, where the winning bid in an auction exceeds the intrinsic value of the item. It notes that rational theories assume all bidders know the value, but aggressive bidding and many bidders can cause overpayment. The winner's curse is more likely with more bidders and aggressive bidding, as the winner may pay over 25% above the true value.

Uploaded by

Das Randhir
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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 The Winner's Curse

a tendency for the winning bid in an auction setting to exceed the intrinsic value of the item purchased -
suggest that this is not the case.

Rational-based theories assume that all participants involved in the bidding process will have access to
all relevant information and will all come to the same valuation. Any differences in the pricing would
suggest that some other factor not directly tied to the asset is affecting the bidding.

According to Robert Thaler's 1988 article on winner's curse, there are two primary factors that
undermine the rational bidding process: the number of bidders and the aggressiveness of bidding. For
example, the more bidders involved in the process means that you have to bid more aggressively in
order to dissuade others from bidding. Unfortunately, increasing your aggressiveness will also increase
the likelihood in that your winning bid will exceed the value of the asset.

Consider the example of prospective homebuyers bidding for a house. It's possible that all the parties
involved are rational and know the home's true value from studying recent sales of comparative homes
in the area. However, variables irrelevant to the asset (aggressive bidding and the amount of bidders)
can cause valuation error, oftentimes driving up the sale price more than 25% above the home's true
value. In this example, the curse aspect is twofold: not only has the winning bidder overpaid for the
home, but now that buyer might have a difficult time securing financing.

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