The Winner's Curse (WC) is a phenomenon that may occur in
common value auctions with incomplete information. In short, the winner's curse says that in such an auction,
the winner will tend to overpay. The winner may overpay or be "cursed" in one of two ways:
1) the winning bid
exceeds the value of the auctioned asset such that the winner is worse off in absolute terms; or
2) the value of the asset is
less than the bidder anticipated, so the bidder may still have a net gain but will be worse off than anticipated. However, an actual over-payment will generally occur only if the winner fails to account for the winner's curse when bidding.
The
first formal claim of the WC was made by
Capen, Clap & Campbell (1971), three
petroleum engineers, who argue that oil companies had
fallen into such trap and thus suffered
unexpected low profit rates in the 1960’s and 1970’s on OCS lease sales “year after year.” Many economists argued that this is
bullshit. After all,
such a claim
implies repeated errors and irrationality.
A "
jar experiment" was conducted by
Bazerman &
Samuelson (1983), where a jar of coins was auctioned off to a class. The jar was over-bidded and the winner made a loss.
Kagel & Levin (1986) studied WC and concluded that the WC is “alive and
well” in many auctions, even considering the
rational behaviour of many bidders. So did
Dyer, Kagel, & Levin (1987),
Kagel and Levin (1991),
Kagel, Levin, & Harstad (1995),
Levin, Kagel,
& Richard (1996), and
Kagel & Levin (1999). It was concluded further that even professional bidders
did not out-perform students in the jar experiments.
In
Kagel & Levin (2002), they concluded that the learning to
cope with the WC is
very slow and even if there is learning, results suggests that it is
situation-specific.
In fact, the WC is a phenomenon found in a variety of environments other than auctions.
Cassing & Douglas (1980) and
Blecherman & Camerer (1998) find it in baseball’s free
agency markets.
Dessauer (1981) suggests it exists in bidding for book publishing rights.
Roll
(1986) suggests it exists in corporate takeovers.
Rock (1986) presents a model in which the
observed under-pricing of initial public offerings is a direct result of the WC problem
facing uninformed investors, and
Levis (1990) provides empirical evidence (from British IPOs)
that suggests that the WC and interest rate costs explain this under-pricing.
Experimental work related to the WC has become a
small literature, surveyed in
Kagel
and Levin (2002). It seems that presently
only a few economists doubt the existence of WC-type of behavior in the lab and more and more are willing to accept that such behavior may indeed
exists outside the lab in real markets.
Literature continues to be published as I write.
My Comments
I wept. I didn't realize that at my age, I still can uncover a new concept on my own. This concept was only formalized by experts only in 1971. A mere 44 years ago. Before this, I didn't encounter any literature concerning the existence of WC.
After I have done some research on WC, I realized my concepts are well beyond what the literature has suggested. I am enormously pleased.
My participation with public auctions was not short, a good 2 years. During this period, I was consistently frustrated by the lack of success in all my bids. No matter how high I set my bid budget, there is always this one bidder that bidded way above my limiting bid. In the end, I always ended with none. After a while, I became irrational, I started to bid higher and higher. Fortunately, the great tengri was with me, I was not at all successful in my tries.
But, slowly a pattern began to form. I noticed that auctions that have few bidders like small groups of 2-3, the successful bid is well within expectation. When the group becomes large like 5-6 or more, the successful bid is very irrational to the point of emotional. When the reserved price is low, the bidder group's size is very large. When the reserved price is high, the bidder group's size is very tiny.
With this pattern, I was immediately successful and incurred very little WC on the way. I only bid in auctions that have sufficiently high reserved prices and hence, attract only tiny bidder groups. When this was not the case in time, I just refrain from bidding and enjoy the bidding show in play.
Successful bids done this way tend to be very profitable in gaining values.
Sometimes hidden behind these auctions is the presence of under-covered value, such as the possibility to change its use eventually. This is a very important factor in WC, as any undiscovered value would help to mitigate the WC no matter how ridiculous it seems with the overpayment of asset through WC via auctions.
Another great factor that most literature didn't address is the timing of the market. If the market is bad, the number of bidders would be greatly reduced. In the better days, the number of bidders per auction would similarly be increased, thus making the WC worst ever.
Beta Value
Actually from my observation, WC is just another way of saying volatility, a measure of the asset's beta coefficient. During the market's boom phase, the stocks are sentimentally traded at well above its true value (large number of bidders, rash, unreasonable). While during the market's bane phase, the stocks are sentimentally traded at well below its true value (small number of bidders, conservative, reasonable).
Therefore, if I trade during the boom periods, I would easily make a loss (maximum WC). But, if I trade during the bane periods, I would easily make a gain (minimum WC). Players are too emotional and over-reactive to sentiments. They release their assets easily during bad times, but clingy during good times.
In sum, WC is nothing new, just another way of addressing an existing phenomenon present in the common market place. Noticed Warren Buffet never trade during boom phase, he always picks his winners during the bane phase and exacts very painful conditions for the loans dished out to the ailing targeted companies.
I cannot behave differently.
Success Bid
Sometimes it is easy to start blaming everyone else that the market is so irrational and the success bid is way too high. As a result, the winner just wants to win the bid, but not take the prize. My submission is that if the bid is not beyond everyone else's reach, then how on earth any one in the market allows the winner to walk away with the prize without paying very dearly for that honour in the first place.
Due to monetary inflation (the incessant money printing), real estate in the longer haul is always upward trending, survive the initial limiting conditions, all would end well. This is indeed a nice journey. A little bit emotional but that's the reason in the first place why there are always over-bidding.
Public Auction is Good
Qualifier: Bank auction's reserved price is
always marked at at least 30% off its true market value so that the
asset can be sold quickly to recover its monetary value. The bank is not
interested in maximizing the loser asset owner's asset value. Therefore, participating in auctions would make good sense.
When there is high reserved price, it implies that the reserved price of the underlying asset value is high. Participating in higher reserved price attracts less number of bidders.
Footnote:
One blooded relation asked, "Even during bad times now, the number of bidders are still too many."
It is of course true. Even in bad times, there are still assets that are very attractive to the folks. So during the auctions of these assets, more bidders than expected would still participate. If one has the stomach to fight the game, one could still win at all costs and the WC would be higher than average, but would still be much lower than during those boom times, where one could easily see 100+ bidders for one tiny piece of land.
Another take of the situation is the times currently is still not hard enough due to the presence of money-printing press. Give it a while more, interesting times ahead.
To many, printing money is no sin. Therefore, one should exercise a little more patience when it comes to market crashes. No one like to sell during market crashes, but do they have a choice?
