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Optimistic irrationality and overbidding in private value auctions

Published online by Cambridge University Press:  14 March 2025

Sotiris Georganas ,
Dan Levin  and
Peter McGee Open the ORCID record for Peter McGee [Opens in a new window]
Sotiris Georganas
Affiliation:
City University London, Social Sciences Building, St John Street, London EC1R 0JD, UK
Dan Levin
Affiliation:
Ohio State University, 1945 N. High Street, Columbus, OH 43210, USA
Peter McGee*
Affiliation:
University of Arkansas, Business Building, Fayetteville, AR 72701, USA
*
[email protected]
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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

AuctionsDominant strategyOut of equilibrium payoffs

JEL classification

D44: Auctions C92: Laboratory, Group Behavior D82: Asymmetric and Private Information • Mechanism Design
Type
Original Paper
Information
Experimental Economics , Volume 20 , Issue 4 , December 2017 , pp. 772 - 792
Copyright
Copyright © 2017 Economic Science Association

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Footnotes

Electronic supplementary material The online version of this article (doi:https://doi.org/10.1007/s10683-017-9510-y) contains supplementary material, which is available to authorized users.

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Auction experiment
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Examining the consistency of joy of winning
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