kagel levin-the winner′s curse and public information.ppt

Kagel Levin:The Winner’s Curse and Public Information in Common Value Auctions Economics 328 Spring 2004 What is the Winner’s Curse? Roughly, auctions can be divided into three classes. In a private value auction, individuals values for the object being auctioned are determined independently of each other. Thus, knowing my own value tells me nothing about the value of the object for other bidders. In a common value auction, the object has an identical value for all bidders. As such, variance in bids can only arise from differences of opinion about what the common value of the object actually is. An affiliated value auction is an intermediate case. Like a private value auction, the value of the item being auctioned is different for each bidder. Unlike a private value auction, these values are positively correlated among bidders. Thus, knowing my value for the item tells me something about the value of the item for other bidders. In reality, most auctions are affiliated value auctions. For common and affiliated value auctions, we often assume that bidders are imperfectly informed about the item’s value. Rather than knowing the value, each bidder has a noisy estimate of its value. While the value is the same for all bidders, the estimates are all different. What is the Winner’s Curse? The “winner’s curse” is a phenomenon that affects both common value auctions and affiliated value auctions. In such auctions, it has been frequently observed that winner bidders tend to overbid. This substantially reduces their winnings below the levels predicted by theory, often leading to losses rather than profits. In the words of Kagel and Levin, “You win, you lose money, and you curse.” The occurrence of the winner’s curse was first noted for OCS (off-shore oil) auctions. It has been claimed that the winner’s curse occurs in a number of other markets as well – book publication rights, free-agency for professional baseball, corporate takeovers, IPOs, and real estate.