Consider this scenario: It’s a Saturday morning, and you’re at your local auction house to bid on a new car. There are 20 other bidders present, and you know there will be stiff competition to walk away with this item. Knowing the stakes, you end up winning the car with not only the highest bid, but a bid that is higher than market value.
This should be a happy moment. Instead, you’re met with regret even in victory – a feeling known as the winner’s curse. This blog will expand on the winner’s curse and provide some tips on how not to succumb to it.
The phrase winner’s curse is best described as the difference between the actual value of the item versus the amount paid for by the winning bidder. The word “curse” applies because the winning bid costs you more and also doesn’t provide the same emotional payoff since you feel you overspent.
The winner’s curse happens for several reasons, most notably because bidders have access to different information and interpret that information differently. These differences lead to overestimation’s in terms of what to bid. It also doesn’t help that the process of valuation is subjective – an auction value is determined by what someone deems is worthy enough to pay for.
In certain situations, a bidder may have less information than another fellow bidder. In the example above of the new car, one of the bidders may be an auto dealer who has years of experience in the business. That dealer knows the ins and outs of how to value a car. This discrepancy increases the likelihood of a bidder having the winner’s curse.
Uncertainty also increases the chances of the winner’s curse. Storage unit auctions are a good example of this. You can’t look inside boxes – only from afar – so there is a level of uncertainty when bidding on a unit. Sometimes you strike gold and the contents pay off, while other times it turns into a loss. In times of uncertainty, the human brain has a tendency to act on emotions and feelings instead of logic.
More popular auctions that draw a crowd will also make it more likely that the winning bidder walks away with feelings of the winner’s curse. The logic here is straightforward – more bidders equals more competition and the increased likelihood of overbidding.
The idea of a winner’s curse creates a difficult predicament. You have to be aggressive to win a bid, but bidding a high amount can result in you second guessing the decision making.
Part of the winner’s curse has to do with which type of model a bidder uses to value auction items. There are two models: common value and private value.
Also known as market value, the value is the same for all bidders. In other words, the playing field is level to start and the market determines how much the item is worth.
An example of this is a commercial real estate auction. Assuming the bidders have no personal ties to the property, bidding decisions are determined by what the bidder deems to be true value. In other words, market value will vary based on what each bidder plans to do with the property – one company may view it as more profitable and bid higher, thus resulting in the winner’s curse.
Conversely, private value is when the perceived value is different for bidders, thus influencing how much to bid on an item.
An example of this is an item of sentimental value that, in theory, doesn’t have a price tag. You may have a book collection passed down generation to generation in your family. If you see a book in that same collection at an auction, you will value it differently than other people at the auction since you have a personal tie. The winner’s curse typically doesn’t apply to private value auctions, as these items tend to be “priceless.”
Truthfully, the only way to outright avoid the winner’s curse is to bid such a small amount so you don’t win the auction. Obviously, this ultra conservative strategy isn’t feasible because you’ll never end up with anything or be able to make a profit.
Instead, going into an auction with a rational thought process is one of the easiest ways to lower your risk of the winner’s curse. By using an analytical approach, you can estimate an item’s value and then bid a fraction of that estimate.
Recently, Harvard Law School provided tips on dealing with the dreaded winner’s curse. Here is a brief overview of three steps to take:
Determining the model refers to whether the auction is common value or private value. In general, most auctions are of the common value variety where the value of an item is the same for everyone attending the auction.
Once you have the model, you then need to find an edge over your competitors. This can come in the form of research or unique knowledge. It’s also important to be able to adjust on the fly and find a reason why the value you place on an item is higher than other bidders. These steps will help prevent you from bidding out of pure emotion during an auction.
For example, if you’re at an auto auction and find during the research process that the transmission of a certain car tends to break down at 100,000 miles, you can use that information to estimate how much to bid.
Finally, you should always feel comfortable making a bid. Uncertainty during an auction is an easy way to second guess yourself and succumb to the winner’s curse.
For more auction tips and how to make the most of your auction experience, visit our blog. Check our upcoming auctions page to stay in the know. You can also contact us at (405) 266-2709 for more information about selling your items at an auction.
