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The Origin of the Winner's Curse: A Laboratory Study

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Author Info
Gary Charness (University of California, Santa Barbara)
Dan Levin (Ohio State University)

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Abstract

The Winner's Curse (WC) is one of the most robust and persistent deviations fromtheoretical predictions that has been established in experimental economics and claimed to exist in many field environments. There have been many attempts to explain the winner's curse, such as ignoring the cognition process of other agents, having a cursed system of beliefs, the presence of level-k heterogeneity and beliefs, and/or misunderstanding the game. In order to capture the underlying roots of this behavior, we design and implement in the laboratory a simplified version of the Acquiring a Company game. Our transformation reduces the game to an individual-choice problem, but one that still retains the key adverse-selection issue that results in the WC. We also conduct a treatment in which one can vastly simplify the problem using ordinal reasoning rather than cardinal reasoning. Our main results find that the WC is alive and well in all of these environments where equilibrium theories, based on relaxed belief structures, are mute. Our results also suggest that the WC is better explained by bounded rationality of the form that people have difficulties either performing Bayesian updating or performing contingent reasoning on future events. To delve more deeply into the issue, we added a treatment that presents the game as a choice among simple lotteries that are equivalent to the bidding choices available, but which circumvents the need to perform contingent reasoning on future events.

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Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number 17-07c.

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Date of creation: 18 Jul 2007
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Handle: RePEc:cdl:ucsbec:17-07c

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Related research
Keywords: winner's curse; auction; experiment; take-over game; acquire-a-company game;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Holt, Charles A & Sherman, Roger, 1994. "The Loser's Curse," American Economic Review, American Economic Association, vol. 84(3), pages 642-52, June. [Downloadable!] (restricted)
  2. Ball, Sheryl B. & Bazerman, Max H. & Carroll, John S., 1991. "An evaluation of learning in the bilateral winner's curse," Organizational Behavior and Human Decision Processes, Elsevier, vol. 48(1), pages 1-22, February. [Downloadable!] (restricted)
  3. Roll, Richard, 1986. "The Hubris Hypothesis of Corporate Takeovers," Journal of Business, University of Chicago Press, vol. 59(2), pages 197-216, April. [Downloadable!] (restricted)
  4. Colin M. Campbell & John H. Kagel & Dan Levin, 1999. "The Winner's Curse and Public Information in Common Value Auctions: Reply," American Economic Review, American Economic Association, vol. 89(1), pages 325-334, March. [Downloadable!] (restricted)
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  5. Hendricks, Kenneth & Porter, Robert H, 1988. "An Empirical Study of an Auction with Asymmetric Information," American Economic Review, American Economic Association, vol. 78(5), pages 865-83, December. [Downloadable!] (restricted)
  6. Reinhard Selten & Klaus Abbink & Ricarda Cox, 2005. "Learning Direction Theory and the Winner’s Curse," Experimental Economics, Springer, vol. 8(1), pages 5-20, April. [Downloadable!] (restricted)
  7. Rock, Kevin, 1986. "Why new issues are underpriced," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 187-212. [Downloadable!] (restricted)
  8. Dyer, Douglas & Kagel, John H & Levin, Dan, 1989. "A Comparison of Naive and Experienced Bidders in Common Value Offer Auctions: A Laboratory Analysis," Economic Journal, Royal Economic Society, vol. 99(394), pages 108-15, March. [Downloadable!] (restricted)
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  9. Levin, Dan & Kagel, John H & Richard, Jean-Francois, 1996. "Revenue Effects and Information Processing in English Common Value Auctions," American Economic Review, American Economic Association, vol. 86(3), pages 442-60, June. [Downloadable!] (restricted)
  10. JEFFREY J. LElTZlNGER & JOSEPH E. STIGLITZ, 1984. "Information Externalities In Oil And Gas Leasing," Contemporary Economic Policy, Western Economic Association International, vol. 2(5), pages 44-57, 03. [Downloadable!] (restricted)
  11. Carroll, John S. & Bazerman, Max H. & Maury, Robin, 1988. "Negotiator cognitions: A descriptive approach to negotiators' understanding of their opponents," Organizational Behavior and Human Decision Processes, Elsevier, vol. 41(3), pages 352-370, June. [Downloadable!] (restricted)
  12. Levis, Mario, 1990. "The Winner's Curse Problem, Interest Costs and the Underpricing of Initial Public Offerings," Economic Journal, Royal Economic Society, vol. 100(399), pages 76-89, March. [Downloadable!] (restricted)
  13. Kagel, John H & Levin, Dan & Harstad, Ronald M, 1995. "Comparative Static Effects of Number of Bidders and Public Information on Behavior in Second-Price Common Value Auctions," International Journal of Game Theory, Springer, vol. 24(3), pages 293-319.
  14. Timothy Feddersen & Wolfgang Pesendorfer, 1996. "Convicting the Innocent: The Inferiority of Unanimous Jury Verdicts," Discussion Papers 1170, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
  15. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August. [Downloadable!] (restricted)
  16. Charles A. Holt & Susan K. Laury, 2002. "Risk Aversion and Incentive Effects," American Economic Review, American Economic Association, vol. 92(5), pages 1644-1655, December. [Downloadable!]
  17. Robert Dorsey & Laura Razzolini, 2003. "Explaining Overbidding in First Price Auctions Using Controlled Lotteries," Experimental Economics, Springer, vol. 6(2), pages 123-140, October. [Downloadable!] (restricted)
  18. Erik Eyster & Matthew Rabin, 2002. "Cursed Equilibrium," Department of Economics, Working Paper Series 1045, Department of Economics, Institute for Business and Economic Research, UC Berkeley. [Downloadable!]
  19. Gneezy, Uri & Potters, Jan, 1997. "An Experiment on Risk Taking and Evaluation Periods," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 631-45, May.
  20. Thaler, Richard H, 1988. "Anomalies: The Winner's Curse," Journal of Economic Perspectives, American Economic Association, vol. 2(1), pages 191-202, Winter. [Downloadable!] (restricted)
  21. Brit Grosskopf & Yoella Bereby-Meyer & Max Bazerman, 2007. "On the Robustness of the Winner’s Curse Phenomenon," Theory and Decision, Springer, vol. 63(4), pages 389-418, December. [Downloadable!] (restricted)
  22. Gary Charness & Dan Levin, 2005. "When Optimal Choices Feel Wrong: A Laboratory Study of Bayesian Updating, Complexity, and Affect," American Economic Review, American Economic Association, vol. 95(4), pages 1300-1309, September. [Downloadable!]
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  1. John D. Burger & Stephen J.K. Walters, 2006. "The Existence and Persistence of a Winner’s Curse: New Evidence from the (Baseball) Field," Working Papers 0625, International Association of Sports Economists. [Downloadable!]
  2. Ricardo Gonçalves & John D Hey, 2007. "Experimental Evidence on English Auctions: Oral Outcry vs. Clock," Discussion Papers 07/09, Department of Economics, University of York. [Downloadable!]
  3. Vincent P. Crawford & Nagore Iriberri, 2005. "Level-k Auctions: Can a Non-Equilibrium Model of Strategic Thinking Explain the Winner's Curse and Overbidding in Private-Value Auctions?," Levine's Bibliography 784828000000000604, UCLA Department of Economics. [Downloadable!]
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