The Winner’s Curse
The winners curse is a phenomenon where the winner of an auction almost always has a negative payout, especially when the value of the item is unknown at the time of the auction. Thaler describes an experiment where a student auctions off a jar of coins (value unknown to the buyers) to her class: the expected value of the jar by her class was much less than its true worth, but the highest bid was much more than its true worth. He also describes a buy-a-firm experiment, where each subject (pretending to be the owner of a company) makes a bid on the value of another company they wish to buy out, which is worth 50% more under new management; however, the true value of the company is unknown. Thaler found that each participant fell for the trap and bid high, rather than following the optimal strategy of bidding nothing or just 1$. He also found that many participants did not learn this even after repeated trials.
This suggests that the rules of bidding taught in class are subject to the winner’s curse when the value is determined after the auction. A range of values are independently hypothesized by each of the bidders (either through intuition or from the opinion of expert) and inevitably some will bid more than the true worth of the item, even taking to account the risk-averse tendencies of most bidders. An interesting application of this phenomenon was to prove collusion in various markets, such as the MLB free agent market, stock market, and corporate takeovers, where winning bids were much lower than the true price of the item, even when experts valued the item higher.
Thaler, Richard H. “Anomalies: The winner’s curse.” The Journal of Economic Perspectives (1988): 191-202.