DP3975 Precautionary Bidding in Auctions

Author(s): Péter Esö, Lucy White
Publication Date: July 2003
Keyword(s): english auctions, first-price auctions, prudence, risk, risk-aversion, second-price auctions, winner's curse
JEL(s): D44, D81
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3975

We analyse bidding behaviour in auctions when risk-averse buyers bid for a good whose value is risky. We show that when risk in the valuations increases, DARA bidders will reduce their bids by more than the appropriate increase in the risk premium. Ceteris paribus, buyers will be better off bidding for a more risky object in first-price, second-price, and English auctions with affiliated common (interdependent) values. This ?precautionary bidding? effect arises because the expected marginal utility of income increases with risk, so buyers are reluctant to bid so highly. We also show that precautionary bidding behaviour can make DARA bidders prefer to bid in a common values setting than a private values one when a risk-neutral or CARA bidder would be indifferent. Thus the potential for a ?winners curse? can be a blessing for rational DARA bidders.