The Winners Curse

Table of Contents
1. Introduction The Theory of Winners Curse. How does one define the Winners Curse? 2. Context - What are some real world examples of this anomaly? 3. Existing Literature What are some samples of published books and papers on the subject?

4. Review 3.5 minute video. A salient example to illustrate the type of losses this anomaly is responsible for.

Theory of Winners Curse

Approximately, there are 3 categories of auctions In a private value auction, individuals values for the object being auctioned are determined independently of each other. So, knowing my own private value signals nothing about the value of the object to others. In a common value auction, the object is identical in value for all bidders. Thus, the visible signal of varying bids arises from differences of opinion about what the true value of the object actually is. An affiliated value auction is somewhere between a private value and a common value auction. While the value of the item being auctioned is different for each bidder, these values are positively correlated among bidders. Thus, knowing my own value signals something about the value of the item for other bidders. In reality, most auctions fall under this categeory.

Simple Model of a Winners Curse

3 individuals are bidding for a picture. Incomplete information sealed-price first bid auction, where only one bid per person and bids are made independently Picture is appraised in an auction setting at $9 million. Let T = bid amount in this example. Bid Probability this is the winning bid T=8 = 1/3 * 1/3 * 1/3 = 1/27 = 3.7% T=9 = 1 .037 .704 = 7/27 = 25.9% T = 10 = 1- 2/3 * 2/3 * 2/3 = 19/27 = 70.4%

Simple Model of a Winners Curse

E(winning bid) = $9.667 million > $9 million. In more than 70% of the time the winner of the auction pays more than the picture is worth.

Real World examples

Oil drilling At the start of the 1940s, oil companies began the race to secure drilling rights. By 1960, despite many offshore wells were already in production, it became common knowledge that this business was unprofitable. Based on three ARCO employees research, estimates found in ARCOs oil-drilling bidding history would sometimes differ tenfold between two bidders competing for the same site.

Other examples
Governments auction (3G) mobile telecommunication spectrums, CO permits, and defense contracts.
2

(IPOs) are also an example, since bidders need to estimate what the market value of a company stock will be. Internet business auction websites, such as E-bay, are a significant example of a common occurrence of the winners curse .

Existing Literature
"The Winner's Curse: Paradoxes and Anomalies of Economic Life" by Richard H Thaler The winners curse occupies one relatively short chapter in the book. There are the familiar examples of auctions of jars of coins, and the seminal paper on the bidding for oil-field drilling rights (Capen, Clapp & Campbell. 1971), which first coined the phrase Winners Curse.

Existing Literature
Kagel & Levin: The Winners Curse and Public Information in Common Value Auctions Does experience with first price common value auctions reduce occurrence of the winners curse? If experience does reduce overbidding, can we say something about what subjects are learning? The theory suggests that a larger correction for the winners curse is needed in settings where the number of bidders is large.

Kagel & Levin (Continued)

For all of the auctions in this paper, the value x was distributed uniformly over a range [-x,+x] that was common knowledge. After x is drawn, each subject then receives a signal about the value that is distributed uniformly over the interval [x , x+]. The value of is commonly known to all bidders. Below is the risk neutral nash equilibrium bid function. The final term goes to zero rapidly as we depart the lower end of the distribution, so normally a bidder should bid only slightly above the minimum possible value of the objects signal.

Existing Literature
The winner's curse with independent private values. by Olivier Compte This paper challenges the view that the winners curse anomaly is attributed only to common value or affiliated value auctions. Uniquely, this author uses the approach introduced by Capen and al. (1971) and extends this insight to independent private value settings where costs are drawn from independent distributions and where bidders have imperfect estimates of their own valuation.

Too early to confirm example

Corporate Olympics

Olympic Games!
http://www.cbc.ca/video/watch/EmbeddedOnly/News/ID=2261856745

Olympic Costs

Ballooning Costs
Olympic security costs 2012 London $1.6 billion 2010 Vancouver $1 billion 2008 Beijing $6.5 billion (estimated) 2006 Turin $1.4 billion 2004 Athens $1.5 billion 2002 Salt Lake City $500 million 2000 Sydney $180 million

*all in US $

Overconfidence (Moore and Healy, 2008)

Overestimation: overestimation of ones actual ability, performance, level of control, or chance of success. Overplacement: people believe themselves to be better than others, such as when a majority of people rate themselves better than the median. Overprecision: excessive certainty regarding the accuracy of ones beliefs

Social Image (Ariely et al., 2009)

Hypotheses derived from Benabou and Tirole (2006) (see also McConnell and Linardi, 2011) ImageMotivation HypothesisCeteris paribus, changing visibility changes the level of prosocial activity. For a positive image, increasing visibility increases the level of prosocial activity. Effectiveness HypothesisExtrinsic rewards are less effective the greater is the visibility of the prosocial act.