Overcoming Winner’s Curse
As stated in lecture, auctions are useful for sellers when they are unaware of buyers’ willingness to pay for a good. However, auctions serve as a benefit to sellers, and a loss for buyers, when there is already an established selling price for said good. This twist comes in the form of the Winner’s Curse. Not only will buyers spend what they would ordinarily be willing to, but they will often bid, and thus pay, prices higher than those at which they value the goods at auction.
According to the PON staff at Harvard, bidders often become misled by the desire to “win” auctions by being the one to take home the lot. With this goal clouding their judgement, however, they easily lose track of their true payoff and end up as a net loser by increasing their bids until they win, exceeding their personal values of the lot and thus spending more money than their “earnings” are worth. In one described case, back in 2012, Munch’s The Scream was purchased at $120 million, a price so high that the audience broke into applause as the bid was placed.
Everyone has a different value for what they see. While some are willing to spend millions, others are unable to do so. So how can we avoid paying more than our own values and becoming victims of the Winner’s Curse? The PON staff suggests asking yourself a questions before bidding: “Would you feel particularly comfortable making a particular offer if you knew that all other bidders value the asset less than you did?” Everyone has their own personal value for any given good. Yet when we get caught up in the action of an auction, it is not uncommon to forget or inflate that value. Here is where our strategies discussed in lecture come into play. Keeping in mind the dominant strategy to never bid higher than one’s own value, it is easy to avoid overspending on an auction. If a bidder simply determines their own value prior to the start of the auction, they bare it in mind throughout the bid and hold themselves to not exceed it in their bids. With this in mind, a bidder is sure to end the auction without a negative payoff. At the worst, they leave the auction exactly how they entered it – with no lot, but with all of their savings. At the best, they’ll score a bargain and win a better deal than they’d ever have bargained for,.