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Sport and Competition
The Winner's Curse
Some Behavioural Economics of Bidding and Information
Posted July 29, 2015
Sony recently won a “bidding war” for an Emoji themed movie, after outbidding two other major studios. This could turn into a great film, and stand alongside similar classics based on apparently unpromising themes such as Battleship, Howard the Duck, and Mars Needs Moms. But a bidding war can lead to the Winner’s Curse, the often observed tendency for people to pay more than they should whenever they are competing over price.
Most of us recognise the winner’s curse, but only after the fact. If we have to bid more than somebody else to get something, there is a good chance we will pay more than we wish we had for that something, once the dust has settled.
What is that cause of the curse? Part of it is the tendency to get emotional once bidding starts, and to treat the whole thing as a competition. But when economists and psychologists refer to the winner's curse they refer to a more general tendency, which is that we chronically fail to consider what the other bidder’s choices tell us about the value of what we are bidding for. Or, more generally, we fail to realise—at the moment of making an offer—what the response to that offer will tell us about the value of what we are bidding for.
Lets back up a bit and think of a trade between two people. You are a dealer in stamps, and you are interested in a specific rare stamp, which you believe can be sold for $100 at auction. You don’t care about this stamp except for its resale value. You find a dealer willing to sell you the stamp for $80, and you quickly buy the stamp, concluding you have made a tidy $20 profit.
But, you might reflect, why was that dealer so willing to sell you the stamp for a bargain price? Probably because she values the stamp less than you. She might, therefore, know (or at least believe) something you don’t. The winner’s curse is that you did not take into account that information, before you bid on the stamp.
How could you have? You obviously cannot know how a seller will respond to any given offer, but you can work out if you would be happy if the seller accepted your offer, given that once the offer is accepted you will know that the seller believes the stamp was worth no more than your bid. That is, are you willing to pay $80 for a stamp that you think is worth $100, but that another dealer thinks is worth less than $80?
(The Seller is in the same situation. If she thinks the stamp is worth $60, she has to ask if she is willing to sell it for $80, given that another dealer thinks it is worth more than $80.)
Probably we all understand this intuitively. If you make an offer for a house, and the seller accepts the offer, you might think that perhaps you offered more for the house than it was worth.
Suppose that you are not just competing with the seller, but with other buyers. This is where the “winner’s” curse. You estimate the value of a stamp to be $100—the amount you expect the stamp will be worth when you attempt to resell it. Your estimate could be high or low, but you can’t be sure either way. You bid based on your estimate, as does everyone else.
You win. What does that mean? Well, suppose all the bidders are like you. All have made error prone estimates of the value of the stamp, and bid based on those estimates. The winner is the bidder with the highest estimate, which means the one who overestimated the stamp’s value by the most. The more bidders, the greater the value overestimate.
The winner’s curse has been widely studied by psychologists, and the results, perhaps not too surprising, is that in general, we tend to put a lot of weight on our personal information (what we think the stamp is worth, or the house, or the emoji movie), and practically none on the private information held by other people. Ignoring this “hidden information” leads not only to the winner’s curse, but to a host of other decision biases, such as overconfidence.
Note: Many experiments have been conducted on the winner’s curse. The best place to start is this classic by Richard Thaler.
