9781118041581

probably overestimated the true value. Put another way, conditional on winning

the auction, the buyer should figure the item’s true value to be significantly less than its

original estimate. The upshot is that each buyer should estimate the tract’s value

by first discounting its original estimate before making a bid.

The potential size of the winner’s curse depends on two factors: the degree

of uncertainty surrounding the item’s value and the number of bidders.

Obviously, the winner’s curse is impossible if there is no uncertainty. No firm

knowingly will bid above the item’s true value. The larger the dispersion of esti-

mates and therefore the dispersion of bids, the greater the degree of overbid-

ding by the winning buyer. A more subtle point is that an increase in the

number of bidders raises the frequency of the winner’s curse. As the number

of bidders rises, so will the range of actual estimates and bids. If there are only

two bidders, it is unlikely that either will hold an estimate in the extreme right

tail. But when there are many bidders, the presence of one or more optimistic,

right-tail bidders becomes much more likely.

How much should a buyer discount his original estimate to assess correctly

the item’s true “acquisition” value and so avoid the winner’s curse? First, the

buyer’s bid discount depends on the degree of uncertainty surrounding the

item’s value. If uncertainty is great so that an optimistic estimate is likely to be

30 percent too high on average, the bid discount must be at least this large.

Second, as the number of bidders increases, the bid discount should increase—

that is, a buyer’s sealed bid should be reduced. Winning against a greater num-

ber of bidders means that the buyer’s estimate is farther in Figure 16.2’s right

tail. To avoid overpaying, the buyer must fashion a bid that is at a greater discount

686 Chapter 16 Auctions and Competitive Bidding

FIGURE 16.2

The Winner’s Curse

When the value of the

item is highly

uncertain, a winning

bid drawn from the

right tail of the bid

distribution may

exceed the true value

of the item.

Bids (B) Estimates (E)

B V

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