Optimistic irrationality and overbidding in private value auctions

Original Paper

Abstract

Bidding one’s value in a second-price, private-value auction is a weakly dominant solution (Vickrey in J Finance 16(1):8–37, 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.

Keywords

Auctions Dominant strategy Out of equilibrium payoffs 

JEL Classification

C92 D44 D82 

Supplementary material

10683_2017_9510_MOESM1_ESM.pdf (20 kb)
Electronic supplementary material 1 (PDF 20 kb)
10683_2017_9510_MOESM2_ESM.pdf (224 kb)
Electronic supplementary material 2 (PDF 225 kb)

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Copyright information

© Economic Science Association 2017

Authors and Affiliations

  1. 1.City University LondonLondonUK
  2. 2.Ohio State UniversityColumbusUSA
  3. 3.University of ArkansasFayettevilleUSA

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