English Auctions with Loss Averse Bidders

Abstract

A lot of experimental evidence document that people are loss averse and that the compensation that they require to give up a possession of a good is higher than the amounts they agree to pay to get this possession. This paper analyzes how optimal English auction design changes when we take people's loss aversion into account. It shows that the order in which bidders place their bids does matter and that the first bidder always has an advantage. We analyze how the choice between English and second-price sealed-bid auctions and the optimal reserve price in the English auction depend on the degree of bidders' loss aversion and on seller's valuation of the object. We show that it might be optimal for a seller to set a reserve price below his own valuation of the object. We also show that a seller who wants to maximize his expected revenue should implement the open-bid English auction.