Question

After a first-price, sealed bid common values auction, John, another bidder, laughs at you because you won the auction by bidding $100,000 and the average value of all the bids is only $70,000. The standard of deviation of the bids is $10,000.

a. How is this the winner’s curse? Explain
b. John claims that he is 100% certain you will find out soon that you overbid and the actual value will be less than $100,000. Can John be wrong? Explain.

Answer 1

Part A:

Winner's curse occurs when one participates in an auction for the purchase of a business and their (winner's) bid exceeds the value of the auctioned asset. The value of the asset is less than that anticipated by the bidder, so the bidder may have won the auction but will still be worse off than anticipated.

In this case, the average bids were just $70000 and the winner bid it for $100000 which is much higher then the original value, hence it's a Winner's Curse...

Part B:

Hypothesis:

H0: U > 100000

Ha: U < 100000

(U is the mean bid)

So,

So, z = (70000 - 100000)/10000 = -3

P(Z < -3) = 0.0013

As, the P value is less than 0.05, in this case, the null hypothesis is not accepted...

So, U < 100000

John was not wrong in this regard...

End of the Solution...