| Winner's Curse |
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Information AboutWinner's Curse |
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EXPLANATION In a common value auction, the auctioned item is of roughly equal value to all bidders, but the bidders don't know the item's market value when they bid. Each player independently estimates the value of the item before bidding. The winner of an auction is, of course, the bidder who submits the highest bid. Since the auctioned item is worth roughly the same to all bidders, they are distinguished only by their respective estimates. The winner, then, is the bidder making the highest estimate. If we assume that the '' Average '' bid is accurate, then the highest bidder overestimates the item's value. Thus, the auction's winner is likely to overpay. More formally, this result is obtained using Conditional Expectation (which employs conditional densities). We are interested in a bidder's Expected Value from the auction (the expected value of the item, less than the expected price) ''conditioned'' on the assumption that the bidder wins the auction. It turns out that for a bidder's true estimate the expected value is negative, meaning that on average the winning bidder is overpaying. Savvy bidders will avoid the winner's curse by Bid Shading , or placing a bid that is below their Ex Ante estimation of the value of the item for sale — but equal to their Ex Post belief about the value of the item, given that they win the auction. The key point is that winning the auction is ''bad news'' about the value of the item for the winner. It means that he/she was the most optimistic and if bidders are correct in their estimations on average, that too much was paid. Therefore savvy bidders revise their ex ante estimations downwards to take account of this effect. The severity of the winner's curse increases with the number of bidders. This is because the more bidders, the more likely it is that some of them have overestimated the auctioned item's value. In technical terms, the winner's expected estimate is the value of the first Order Statistic , which increases as the number of bidders increases. There is often confusion that winner's curse applies to the winners of all auctions. However, it is worth repeating here that for auctions with private value (i.e. when the item is desired independent of its value in the market), winner's curse does not arise. EXAMPLES Since most auctions involve at least some amount of common value, and some degree of uncertainty about that common value, the winner's curse is an important phenomenon. In the 1950s, when the term ''winner's curse'' was first coined, there was no accurate method to estimate the potential value of an offshore Oil Field . So if, for example, an oil field had an actual intrinsic value of $10 million, oil companies might guess its value to be anywhere from $5 million to $20 million. The company who wrongly estimated at $20 million and placed a bid at that level would win the auction, and later find that it was not worth as much. Other auctions where the winner's curse is significant:
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