Separating probability weighting and risk aversion in first-price auctions

Abstract

In first price sealed-bid auctions, a power probability weighting function is observationally equivalent to a model with constant relative risk aversion. By comparing auctions with different ceilings on a computerized opponent’s bid space, we can separate inverse S-shaped probability weighting as commonly used in the literature and risk-averse preferences from the distribution of observed bids. We find evidence to support both theories in the data. However, we also observe a significant number of violations after accounting for decision noise, which suggest that bidders’ valuations may be malleable to cues of the auction environment. • We design an experiment to separate probability weighting and risk-aversion in bidding. • We vary the beliefs about the opponent without changing the risk neutral optimal bid. • We find evidence to support both probability weighting and risk aversion in the data. • We observe a significant number of violations of both probability weighting and risk aversion. • We find that bidders’ valuations may be malleable to cues of the auction environment.