Hostname: page-component-7b9c58cd5d-9k27k Total loading time: 0 Render date: 2025-03-15T17:37:37.065Z Has data issue: false hasContentIssue false

Explaining Overbidding in First Price Auctions Using Controlled Lotteries

Published online by Cambridge University Press:  14 March 2025

Robert Dorsey
Affiliation:
FNC, Inc., Oxford, MS 38655
Laura Razzolini*
Affiliation:
Department of Economics, University of Mississippi, University, MS 38677, USA; National Science Foundation, Arlington, VA 22230, USA

Abstract

In this paper, we study the behavior of individuals when facing two different, but incentive-wise identical, institutions. We pair the first price auction with an equivalent lottery. Once a subject is assigned a value for the auctioned object, the first price auction can be modeled as a lottery in which the individual faces a given probability of winning a certain payoff. This set up allows us to explore to what extent the misperception of the probability of winning in the auction is responsible for bidders in a first price auction to bidding above the risk neutral Nash equilibrium prediction. The first result we obtain is that individuals, even though facing the same choice over probability/payoff pairs, behave differently depending on the type of choice they are called to make. When facing an auction, subjects with high values tend to bid significantly above the bid they choose in the corresponding lottery environment. We further find that in both the lottery and the auction environments, subjects tend to bid in excess of the bid predicted by the risk neutral model, at least for intermediate range values. Finally, we find that the difference between the lottery behavior and the auction behavior is substantially, but not totally, eliminated by showing the subjects the probability of winning the auction.

Type
Research Article
Copyright
Copyright © 2003 Economic Science Association

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Cox, J. C., Smith, V. L., and Walker, J. M. (1984). “Theory and Behavior of Multiple Unit Discriminative Auctions.” Journal of Finance. 39, 9831010.CrossRefGoogle Scholar
Cox, J. C., Smith, V. L., and Walker, J. M. (1988). “Theory and Individual Behavior of First-Price Auctions.” Journal of Risk and Uncertainty. 1, 6199.CrossRefGoogle Scholar
Dorsey, R. E., Johnson, J. D., and VanBoening, M. V. (1994). “The Use of Artificial Neural Networks for Estimation of Decision Surfaces in First Price Sealed Bid Auctions.” In Cooper, W.W. and Whinston, A. (eds.), New Directions in Computational Economics, Kluwer, pp. 1940.CrossRefGoogle Scholar
Fox, C.R. and Tversky, A. (1998). “A Belief-Based Account of Decision Under Uncertainty.” Management Science. 44, 879895.CrossRefGoogle Scholar
Friedman, D. (1992). “Theory and Misbehavior of First-Price Auctions: Comment.” American Economic Review. 82, 13741378.Google Scholar
Harlow, W. V. and Brown, K. C. (1992). “The Role of Risk Tolerance in the Asset Allocation Process: A New Perspective.” The Research Foundation of the Institute of Chartered Financial Analysts, Charlottesville, VA. Harrison, G.W. (1989). “Theory and Misbehavior of First-Price Auctions.” American Economic Review. 79, 749762.Google Scholar
Harrison, G. W. (1989). “Theory and Misbehavior of First-Price Auctions: Reply.” American Economic Review. 82, 14261443.Google Scholar
Kagel, J. H. (1995). “Auctions: A Survey of Experimental Research.” In Kagel, J.H. and Roth, A.E. (eds.), The Handbook of Experimental Economics, Princeton, pp. 501585.CrossRefGoogle Scholar
Kahneman, D. and Tversky, A. (1979). “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica. 47, 263291.CrossRefGoogle Scholar
Kinder, D. R. and Palfrey, T. R. (1993). Experimental Foundations of Political Science. The University of Michigan Press, Ann Arbor.CrossRefGoogle Scholar
McAfee, R. P. and McMillan, J. (1987). “Auctions and Bidding.” Journal of Economic Literature. XXV, 699738.Google Scholar
VanBoening, M. V., Rassenti, S.J., and Smith, V. L. (1987). “Numerical Computation of Equilibrium Bid Functions in a First-Price Auction with Heterogeneous Bidders.” Experimental Economics. 1, 147159.CrossRefGoogle Scholar
Vickrey, W. (1961). “Counter speculation, Auctions and Competitive Sealed Tenders.” Journal of Finance. 16, 837.CrossRefGoogle Scholar