Winner’s Curse Definition
The winner’s curse is a situation where an auction’s winning bid tends to be more than the intrinsic value or the fair value of an item. As the information about the item’s intrinsic value is not accurate, a lot of factors including bidder’s feelings or other subjective elements associated with the item can persuade bidders and make it difficult for them to ascertain the intrinsic value of the item. Ultimately, the bidder, who overestimates the worth of an item, wins the auction.
The winner’s curse tends to be a perfect illustration for buyer’s remorse, where a person buys something, and feels that he or she has paid far more than its real worth.
A Little More on What is the Winner’s Curse
The term ‘winner’s curse’ was devised when the firms started submitting bids for offshore oil drilling rights present in the Gulf of Mexico. In the world of investments, this term is generally applicable for initial public offerings (IPO).
An intrinsic value is subjective in nature. It is based on a person’s opinions, emotions, and judgements. If every person has the right information, and every bidder made totally rational decisions, and expert calculations, there won’t be any chances of paying more than the actual amount. Similarly, when the bubbles in real estate or stock markets are formed, investors become more irrational, and start giving push to the prices so that they go beyond the intrinsic value of the property or stocks.
The winner’s curse is an amalgam of behavioral and emotional patterns. We often realize the winner’s curse once the damage has been done. In an auction, every bidder places a higher bid than others because they want to win the item on auction. And in this process, we usually end up paying beyond our expectations, and this is something that we realize it pretty late.
- The winner’s curse refers to a phenomenon when the winning bid exceeds the real value of the item placed on auction.
- In the absence of complete data, subjective factors and emotions related to the specific item on auction can make it difficult for bidders to ascertain the real value of the item.
- This term came into existence when firms were bidding for local oil drilling authority in the Gulf of Mexico.
An example of the winner’s curse
For instance, Jim’s Oil, Frank’s Drilling, and Joe’s Exploration are bidding for drilling rights for a specific region. Let’s assume that after assessing the expenses and prospective revenues related to drilling, the intrinsic value of drilling rights is $4 million. Now, let’s consider assuming that Jim’s Oil places a bid for $2 million, Joe’s Exploration for $5 million, and Frank’s Drilling for $7 million.
References for “Winner’s Curse”
Academic research for “Winner’s Curse”
Anomalies: The winner’s curse, Thaler, R. H. (1988). Anomalies: The winner’s curse. Journal of Economic Perspectives, 2(1), 191-202.
The winner’s curse, reserve prices, and endogenous entry: Empirical insights from eBay auctions, Bajari, P., & Hortaçsu, A. (2003). The winner’s curse, reserve prices, and endogenous entry: Empirical insights from eBay auctions. RAND Journal of Economics, 329-355.
The winner’s curse and public information in common value auctions, Kagel, J. H., & Levin, D. (1986). The winner’s curse and public information in common value auctions. The American economic review, 894-920.
Prices and the Winner’s Curse, Bulow, J., & Klemperer, P. (2002). Prices and the Winner’s Curse. RAND journal of Economics, 1-21.
Asymmetric information, bank lending and implicit contracts: the winner’s curse, Von Thadden, E. L. (2004). Asymmetric information, bank lending and implicit contracts: the winner’s curse. Finance Research Letters, 1(1), 11-23.
The winner’s curse in banking,, Shaffer, S. (1998). The winner’s curse in banking. Journal of Financial Intermediation, 7(4), 359-392.
Overpaying in corporate takeovers: The winner’s curse, Varaiya, N. P., & Ferris, K. R. (1987). Overpaying in corporate takeovers: The winner’s curse. Financial Analysts Journal, 43(3), 64-70.
Increasing competition and the winner’s curse: Evidence from procurement, Hong, H., & Shum, M. (2002). Increasing competition and the winner’s curse: Evidence from procurement. The Review of Economic Studies, 69(4), 871-898.
The winner’s curse, legal liability, and the long-run price performance of initial public offerings in Finland, Keloharju, M. (1993). The winner’s curse, legal liability, and the long-run price performance of initial public offerings in Finland. Journal of Financial Economics, 34(2), 251-277.
The winner’s curse: experiments with buyers and with sellers, Lind, B., & Plott, C. R. (1991). The winner’s curse: experiments with buyers and with sellers. The American economic review, 81(1), 335-346.