Inverse S-shaped probability weighting functions in first-price sealed-bid auctions

Abstract

It is often observed in first-price sealed-bid auction experiments that subjects tend to bid above the risk neutral Nash equilibrium predictions. One possible explanation for this overbidding phenomenon is that bidders subjectively weight their winning probabilities. In the relevant literature, the probability weighting functions (PWFs) suggested to explain overbidding imply the underweighting of all probabilities. However, such functions are not in accordance with the PWFs commonly used in the literature (i.e., inverse S-shaped functions). In this paper we introduce inverse S-shaped PWFs into first-price sealed-bid auctions and investigate the extent to which such weighting functions explain overbidding. Our results indicate that bidders with low valuations underbid, whereas those with high valuations overbid. We accordingly conclude that inverse S-shaped PWFs provide a partial explanation for overbidding.