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Standard economic theory assumes that people behave rationally. The winner’s curse implies that people behave irrationally...

Standard economic theory assumes that people behave rationally. The winner’s curse implies that people behave irrationally by paying more for an asset than it is worth. Can we reconcile the winner’s curse with rational behavior?

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Answer #1

When the standard economic theory makes people rational it also assumes that people will use all the available information to accurately predict the future value of a variable. This also indicates that investors in the market will use all the available information and will place a true value to the Asset. In case of winner's curse this rationality is disrupted because there are two elements that encourage bidders to overestimate the true value of underlying asset. These elements are the number of bidders and the aggressiveness of bidding. When there are more number of bidders people tend to bid irrationally in order to win and sometimes this increases the aggression with which bidding is done in order to win among large number of bidders. It is in this sense that we cannot reconcile winner's currse with rational behaviour.

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