Optimistic irrationality and overbidding in private value auctions

Abstract

This is the accepted version of the paper.This version of the publication may differ from the final published version. Abstract Bidding one's value in a second-price, private-value auction is a weakly dominant solution (Vickrey, 1961), but repeated experimental studies find more overbidding than underbidding. We propose a model of optimistically irrational bidders who understand that there are possible gains and losses associated with higher bids but who may overestimate the additional probability of winning and/or underestimate the potential losses when bidding above value. These bidders may fail to discover the dominant strategy-despite the fact that the dominant strategy only requires rationality from bidders-but respond in a common sense way to out-of-equilibrium outcomes. By varying the monetary consequences of losing money in experimental auctions we observe more overbidding when the cost to losing money is low, and less overbidding when the cost is high. Our findings lend themselves to models in which less than fully rational bidders respond systematically to out-of-equilibrium incentives, and we find that our model better fits the effects of our manipulations than most of the existing models we consider. Permanent repository linkJEL classification: C92, D44, D82

Cognitive Ability and Bidding Behavior in Second Price Auctions: An Experimental Study

“…However, this auction mechanism may not always provide an accurate measure of value given behavioral anomalies observed in controlled laboratory experiments. One consistent finding in experimental auction studies is that subjects tend to deviate from rational behavior and exhibit a pattern of overbidding in SPAs (Kagel, Harstad, and Levin ; Kagel and Levin ; Rutström ; Harstad ; Aseff 2004; Andreoni, Che, and Kim ; Cooper and Fang ; Drichoutis, Lusk, and Nayga ; Georganas, Levin, and McGee ).…”

How to run an experimental auction: a review of recent advances

“…It is well known that auction mechanisms may not always provide accurate valuation estimates, given behavioral anomalies on bidding behavior observed in lab experiments. For example, one consistent finding in experimental auction studies is that subjects tend to deviate from rational behavior and exhibit a pattern of overbidding in second price auctions (SPA) (Andreoni et al, 2007;Cooper and Fang, 2008;Drichoutis et al, 2015;Georganas et al, 2017;Kagel et al, 1987;Kagel and Levin, 1993). Kagel et al (1987) inferred that subjects submit a higher bid in SPAs due to the impression that submitting higher bids improves the probability of winning with no real cost because the highest bidder pays the second highest bid.…”

Opportunity cost, inattention and the bidder’s curse

“…Another possibility is that Finding 5 may be related to existing evidence of on average overbidding in second price auctions without an aftermarket (Kagel and Levin, 1993;Ariely et al, 2005;Cooper and Fang, 2008;Georganas et al, 2017 which even substantial experience does not eliminate overbidding (Kagel and Levin, 1993); however, we cannot rule out the possibility that additional experience would eventually eliminate overbidding.…”