Possibility of Losing Own Money Promotes Learning to Reduce Overbidding: Delayed Payment in Experimental Auctions

Abstract

We designed a delayed payment mechanism in second price auction (SPA) experiments, under which subjects receive a cash endowment two weeks after the experiment day and have to use their own money to pay the experimental loss (if any) on the experiment day. We found that bids are significantly lower with delayed payment of endowment, compared to other payment timing schemes including “on-the-spot” and prepaid payment mechanisms. Furthermore, bids converged to their corresponding induced values as subjects gained experience over repeated auction rounds, suggesting a learning effect and lending support to the role of “bounded rationality” in overbidding in SPAs. We conjecture that under a delayed payment mechanism, the possibility of losing one’s own money promotes learning, which in turn reduces overbidding. To test this hypothesis, we examined how the degree of overbidding is affected by the interaction between loss in the previous auction round and the current number of rounds, which is a proxy for experience. This effect is significantly negative with delayed payment, but not significant under other payment timing schemes. These results suggest that loss of one’s own money in previous rounds triggers learning in SPAs and reduces overbidding. Therefore, a mechanism that makes loss costly and provides subjects with sufficient learning experiences can effectively reduce overbidding in laboratory SPAs.