Common-Value Auction

What it is

The classic case is oil under a lease. In 1971 three Atlantic Richfield engineers, E. C. Capen, R. V. Clapp and W. M. Campbell, wrote in the Journal of Petroleum Technology that "a lease winner tends to be the bidder who most overestimates reserves potential", so the successful bidders "may not have been so successful after all." Richard Thaler's 1988 column on the winner's curse reported the 1969 sale of Alaska North Slope leases, where winning bids totalled $900 million and the second-highest bids $370 million.

The cleanest demonstration came from a classroom. In 1983 Max Bazerman and William Samuelson ran 48 sealed-bid auctions among 419 MBA students at Boston University, selling jars of coins or paper clips worth $8. The students' average estimate was $5.13, yet the average winning bid was $10.01, and the average winner lost $2.01. More uncertainty about the contents, and more bidders, widened the loss.

John Kagel and Dan Levin found in 1986 that laboratory bidders in groups of three or four made money, about two-thirds of what theory predicted, while groups of six or seven lost 88 cents per period where theory predicted a $4.68 profit. Theory says a bidder should bid more cautiously as the crowd grows, because winning means having beaten more estimates. The bidders did the opposite.

In effect

Before bidding, ask whether the thing on sale is worth much the same to everyone and whether its value is uncertain. If both are true, your estimate is the one most likely to be too high when you win. The more people bidding, the lower your bid should be, which runs against instinct.

What it does not say

Not every auction is common-value, and the curse is clearest where the prize is worth the same to all and its value is unknown. Thaler cautioned that the Alaska figures were consistent with the curse without proving anyone had behaved irrationally. Most of the clean evidence comes from laboratories with small stakes. In 1996 Douglas Dyer and Kagel found that experienced construction executives suffered the curse in laboratory auctions while doing well in their real trade, which they attributed to industry practices that do not travel to an unfamiliar setting.

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