The Origin of the Winner's Curse: A Laboratory Study

Abstract

The Winner's Curse (WC) is one of the most robust and persistent deviations from theoretical predictions that has been established in experimental economics. We designed and implemented in the laboratory a simplified version of the Acquiring a Company game. Our transformation reduced the game to an individual-choice problem, but one that still retains the key adverse-selection issue that results in the WC. This allows us to isolate the origins of the WC from proposed explanations that have recently been advanced, such as ignoring others' cognition process, having cursed system of beliefs, high variance in payoffs, and/or a misunderstanding of the game. Our main results find that the WC is alive and well in environments where the above explanations are either mute or wrong, and strongly suggest that the WC is better explained by bounded rationality of the form that people have difficulties either performing Bayesian updating or seeing through a complex problem.

Naturally Occurring Markets and Exogenous Laboratory Experiments: A Case Study of The Winner's Curse

“…These results are strikingly complementary to findings from laboratory experiments reported by Charness and Levin (2006). They sequentially strip away all strategic aspects of the environment that leads to the WC.…”

What Makes a Good Trader? On the Role of Intuition and Reflection on Trader Performance

“…The survey included tests for financial literacy and self‐monitoring. In the five high‐stakes sessions, we also included a Bayesian updating test taken from Charness and Levin (). In four of the five high‐stakes sessions, we asked subjects to assess their session rank on the CRT (see Internet Appendix Section V for the corresponding analysis).…”

Viewpoint: On the generalizability of lab behaviour to the field

“…As discussed in the survey of Kagel and Levin (2002), subsequent laboratory experiments have refined the analysis and have shown that the WC is ‘alive and well’ across student subject pools including super‐experienced' bidders (Kagel and Levin 1999) and is a robust phenomenon in many common value auction forms (see, e.g., Kagel, Battalio, and Walker 1995). Charness and Levin (2005, 4‐5) note, ‘It seems that presently only a few economists doubt the existence of WC‐type of behavior in the lab and more and more are willing to accept that such behavior may indeed exist outside the lab in real markets.’…”