Hypothetical thinking and the winner’s curse: an experimental investigation

Abstract

There is evidence that bidders fall prey to the winner’s curse because they fail to extract information from hypothetical events—like winning an auction. This paper investigates experimentally whether bidders in a common value auction perform better when the requirements for this cognitive issue—also denoted by contingent reasoning—are relaxed, leaving all other parameters unchanged. For my underlying research question, I used a lab experiment with two stages. In stage I, the subjects participate in a non-standard common value auction, called the wallet game, in which a naive bidding strategy can lead to both winner’s curse and loser’s curse. In stage II, the subjects in the treatment group learn whether their initial bid was the winning bid or not and they get the opportunity to change this bid. In this sense, the bidders face the same decision problems as in stage I again, but the need for hypothetical thinking is reduced in stage II. The overall pattern of the data suggests that the problem of irrational over- and underbidding can be weakened by giving the subjects ex ante feedback about their bid, but unlike related studies I also find negative effects of additional information.