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Common Value Auctions and the Winner's Curse

Common Value Auctions and the Winner's Curse

John H. Kagel
Dan Levin
Copyright Date: 2002
Pages: 400
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  • Book Info
    Common Value Auctions and the Winner's Curse
    Book Description:

    Few forms of market exchange intrigue economists as do auctions, whose theoretical and practical implications are enormous. John Kagel and Dan Levin, complementing their own distinguished research with papers written with other specialists, provide a new focus on common value auctions and the "winner's curse." In such auctions the value of each item is about the same to all bidders, but different bidders have different information about the underlying value. Virtually all auctions have a common value element; among the burgeoning modern-day examples are those organized by Internet companies such as eBay. Winners end up cursing when they realize that they won because their estimates were overly optimistic, which led them to bid too much and lose money as a result.

    The authors first unveil a fresh survey of experimental data on the winner's curse. Melding theory with the econometric analysis of field data, they assess the design of government auctions, such as the spectrum rights (air wave) auctions that continue to be conducted around the world. The remaining chapters gauge the impact on sellers' revenue of the type of auction used and of inside information, show how bidders learn to avoid the winner's curse, and present comparisons of sophisticated bidders with college sophomores, the usual guinea pigs used in laboratory experiments. Appendixes refine theoretical arguments and, in some cases, present entirely new data. This book is an invaluable, impeccably up-to-date resource on how auctions work--and how to make them work.

    eISBN: 978-1-4008-3013-8
    Subjects: Finance

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-xii)
  3. Preface
    (pp. xiii-xiv)
  4. Credits
    (pp. xv-xviii)
  5. 1 Bidding in Common-Value Auctions: A Survey of Experimental Research
    (pp. 1-84)
    John H. Kagel and Dan Levin

    Auctions are of considerable practical and theoretical importance.¹ In practical terms, the value of goods exchanged in auctions each year is huge. Governments routinely use auctions to purchase goods and services, to sell government assets, and to fund the national debt. Private-sector auctions are common as well, and of growing importance in areas such as deregulated utility markets, allocation of pollution rights, and the large variety of items now being sold via Internet auctions. Auctions are commonly employed when one party to the exchange (for example, the seller) is uncertain about the value that buyers place on the item. Auctions...

  6. 2 First-Price Common-Value Auctions: Bidder Behavior and the “Winner’s Curse”
    (pp. 85-106)
    John H. Kagel, Dan Levin, Raymond C. Battalio and Donald J. Meyer

    Numerous occurrences of the winner’s curse have been reported in bidding for items of uncertain value, resulting in below normal or even negative average profits for bidders. The winner’s curse results from bidders’ failure to account for the adverse selection problem inherent in winning auctions for items of uncertain value. Capen, Clapp, and Campbell [1971] claim that the winner’s curse resulted in low profits for oil companies in the 1960s in bidding on offshore oil and gas leases. Regarding corporate takeovers and mergers, Roll [1986] proposes a hubris hypothesis: acquiring firms generally fall prey to the winner’s curse, paying too...

  7. 3 The Winner’s Curse and Public Information in Common Value Auctions
    (pp. 107-148)
    John H. Kagel and Dan Levin

    Common value auctions constitute a market setting in which participants may be particularly susceptible to judgment failures that affect market outcomes. In a common value auction, the value of the auctioned item is the same to all bidders. What makes the auction interesting is that bidders are unaware of the value of the item at the time the bids are placed. Mineral lease auctions, particularly the federal government’s outer continental shelf (OCS) oil lease auctions, are common value auctions. There is a common value element to most auctions. Bidders for all oil painting may purchase for their own pleasure, a...

  8. 4 Comparative Static Effects of Number of Bidders and Public Information on Behavior in Second-Price Common Value Auctions
    (pp. 149-176)
    John H. Kagel, Dan Levin and Ronald M. Harstad

    In common value auctions the value of the item is the same for all bidders. Before bidding, each of theNbidders privately observes an informative signal (or estimate) which is a random variable affiliated with the value. Affiliation means that a higher estimate for one bidder makes higher estimates for rivals and a higher asset value more likely. Mineral rights auctions, such as outer continental shelf (OCS) leases, are often characterized as common-value auctions; here the signals represent different bidders’ pre-sale estimates of lease value. Any auction of a potentially resalable asset involves a common-value element.

    In common value...

  9. 5 Information Impact and Allocation Rules in Auctions with Affiliated Private Values: A Laboratory Study
    (pp. 177-209)
    John H. Kagel, Ronald M. Harstad and Dan Levin

    A series of auction experiments are reported in which a single indivisible item is auctioned off among six bidders under different information conditions and using different allocation rules. The induced valuations are private and satisfy the criterion of strict positive affiliation (Milgrom and Weber, 1982). With private values each bidder has perfect information concerning the value of the object at auction for him/herself; with affiliation, a higher value of the item for one bidder makes higher values for other bidders more likely. A simple example of an auction with affiliated private values would be a charity fundraiser of consumer perishables,...

  10. 6 Revenue Effects and Information Processing in English Common Value Auctions
    (pp. 210-244)
    Dan Levin, John H. Kagel and Jean-Francois Richard

    In a common value auction, the value of the item is the same to all bidders, but unknown at the time they bid. Rather, bidders have private information correlated with the unknown value. Mineral lease auctions are usually modeled as pure common value auctions, but there is a common value component to most auctions.

    Economic theory predicts that the choice of institution for a common value auction will affect expected revenue. In particular, with symmetric, risk-neutral Nash equilibrium (RNNE) bidding, English auctions are predicted to raise more revenue than first-price, sealed bid auctions. This happens because both the pricing rule...

  11. 7 Common Value Auctions with Insider Information
    (pp. 245-269)
    John H. Kagel and Dan Levin

    This chapter investigates bidding in first-price, sealed bid common value auctions with an asymmetric information structure (AIS). Two types of AIS auctions have been analyzed in the literature. In both cases a single insider (I) has superior (often exact) information about the value of the item. In one caseI’s have a double informational advantage; they are better informed, and less informed bidders (outsiders;O’s) only have access to public information. In this case,O’s employ mixed strategies earning zero expected profits in equilibrium (Wilson (1967), Weverberg (1979), Englebrecht-Wiggans, Milgrom, and Weber (1983), Hendricks, Porter, and Wilson (1994)). In the...

  12. 8 Can the Seller Benefit from an Insider in Common-Value Auctions
    (pp. 270-283)
    Colin M. Campbell and Dan Levin

    Models of auctions in which bidders are ex-ante homogeneous with respect to their private information have given economic theory great predictive mileage. These models have been applied with success to environments of both private and common bidder values, with major results concerning the revenue-raising properties of different auction rules being derived in, for instance, Myerson [10] and Riley and Samuelson [11] for the private values case, and Milgrom and Weber [9] for the general affiliated values case. Important results for environments in which bidders are ex-ante heterogeneous have been harder to discover, as the problem of characterizing equilibrium bidding behavior...

  13. 9 Second-Price Auctions with Asymmetric Payoffs: An Experimental Investigation
    (pp. 284-310)
    Christopher Avery and John H. Kagel

    In the vast literature on auctions the effect of asymmetries between bidders has been little studied. Asymmetries are the norm and not the exception in many auctions. It is common for one bidder to be known to have a special interest beyond that of others in winning the auction. Some examples of this are an oil company bidding for a tract near its other properties, the current managers of a company bidding against outsiders for its, takeover, and the recent FCC broadband MTA auctions.¹

    In the important situation of common values and correlated information, asymmetries can lead to a reversal...

  14. 10 Learning in Common Value Auctions: Some Initial Observations
    (pp. 311-331)
    Susan Garvin and John H. Kagel

    Common value auctions are auctions in which the value of the item is the same to all bidders. However, bidders do not know the value of the item at the time they bid, basing their bids on private estimates (signals) related to the value. Assuming that each individual bidder’s estimate of value is unbiased, and symmetry in bidding strategies (or some reasonable approximation thereof), winning bidders need to account for the adverse selection problem inherent in winning the item: the high bidder has an overly optimistic estimate of the item’s value. Unless this adverse selection problem is accounted for, winning...

  15. 11 Cross-Game Learning: Experimental Evidence from First-Price and English Common Value Auctions
    (pp. 332-339)
    John H. Kagel

    There has been considerable interest among economists in learning models to explain how Nash equilibria might actually be achieved. In learning models equilibria emerge from an adaptive, dynamic adjustment process with players interacting repeatedly in exactly the same game. However, as Fudenberg and Kreps (1988) note, it seems unreasonable to expect to find many situations in which exactly the same game is repeated many times. As such, one would have considerably more faith in the ability of learning mechanisms to achieve equilibrium outcomes if agents were able to transfer their learning across ‘similar’ games.

    Psychologists attribute cross-situation learning to individuals...

  16. 12 A Comparison of Naive and Experienced Bidders in Common Value Offer Auctions: A Laboratory Analysis
    (pp. 340-348)
    Douglas Dyer, John H. Kagel and Dan Levin

    Laboratory economics experiments typically use financially motivated students as subjects. An ongoing issue is whether this is an appropriate subject pool since the students are typically inexperienced in the types of decision-making required of them in the lab. This paper addresses this issue in the context of common value offer auctions as we compare the behaviour of experienced business executives in the construction contract industry (‘experts’) with that of (‘naive’) student subjects. Results of previous research of this sort have been equivocal; in some cases experts make the same errors as novices, in other cases they do not (Hogarth and...

  17. 13 Bidding in Common Value Auctions: How the Commercial Construction Industry Corrects for the Winner’s Curse
    (pp. 349-369)
    Douglas Dyer and John H. Kagel

    Construction contract bidding is usually treated as a common value auction. In a pure common value auction the value of the item is the same to all bidders. What makes the auction interesting is that bidders have different estimates of the true value at the time they bid. Assuming that bids decrease with decreasing cost estimates, the low bidder faces an adverse selection problem, as he/she wins only when he or she has one of the lowest estimates of the cost of construction. Unless this adverse selection problem is accounted for in bidding, the low bidder is likely to stiffer...

  18. Instructions
    (pp. 370-394)
  19. Index
    (pp. 395-401)