What is... | January 6, 2015

What is the winner’s curse?

There’s a coffee table you want up for auction online – but other bidders want it too. Do you keep a cool head and not exceed your maximum price? Or do you get caught up in the moment, outbid the others and pay too much to get the table?

If the answer is the latter – and for many it will be – beware. The “win” of securing the table can be short-lived if you are “cursed” by overpaying. Particularly if you want to sell it later on for a profit.
This “winner’s curse” thinking trap is fuelled by “irrational exuberance”, is easy to fall for, applies to many situations and can be costly.

Winning at any cost?
The winner’s curse is often accompanied by a situation in which there is competition (such as an auction) and when the value of victory can only be estimated in advance.
The 2004 book Beware the Winner’s Curse lists a wide range of situations in which competition has led to overpaying and – ultimately – financial distress for the “winner”. The situations include teams bidding for a top player in professional sports, film rights, acquiring a company and many more. It says the best example was in the United Kingdom in 2000 with the auction of 3G wireless spectrum, which lead to a “frenzy of overbidding”, also seen in 3G auctions in Germany and the Netherlands. It is further explored here. Another example studied by academics is bidding for the Olympic Games, when competing cities often underestimate costs.
The book tells how the term winner’s curse was coined by economists in 1971 when they analysed oil lease auctions in which “winners” paid over the odds.

It’s a human condition
Interestingly, a 2008 study found that the winner’s curse almost disappeared when people bid in an auction against a computer. The authors write that it suggests people value a win over another person (even if it costs them) but not against a computer.
Meanwhile, personality type is argued to play a role in how likely someone is to succumb to the winner’s curse in a 2011 German research paper, with extraverts particularly prone.
Some say the curse can be fuelled by investor overconfidence, as well as cultures that prize the pursuit of strong growth.

Can we reverse the curse?
So how do people avoid succumbing to the winner’s curse? Like many thinking traps, it is difficult.
In a famous 1988 paper Richard Thaler, co-author of the influential book Nudge, wrote that being aware of the winner’s curse is not a remedy for many. After all, if a party reduces their bid in an auction to prevent overpaying, they’re unlikely to win – a potentially unsatisfactory situation.
A solution will be very dependent on individual circumstances. And being aware of the danger is a good first step.
Deciding goals, price and other fundamentals before entering a bidding process might help quell impulsiveness.
After all, there’s probably a limit to how badly you want that coffee table. And if you overspend in the heat of the moment, the table might not look so attractive to you in the long run.

ShoppingBiasBuyer's remorse

eZonomics team
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