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Nobel Prize and the Winner’s Curse

The 2020 Nobel Prize in Economics has been awarded to Milgrom and Wilson for inventing new auction formats. Auctions are designed in different ways to include different rules and different bidding options. We tend think of an auction room with an auctioneer and many potential buyers. We are familiar with a bidding process where bids are called out and the price keep escalating till no one calls out any higher bid and the auction price gets determined – this is typically an “English auction”. In complete contrast, a “Dutch auction” begins with a high price and bids downwards. It is common sense that one would sell items to the highest bidder, and conversely, buy items from the cheapest bidder in an auction. The auction market now includes anything and everything from houses and diamonds to electricity and telecom.

The earliest auction scenario would include a poor insolvent individual who would auction his property to get the highest value. A modern Milgrom-Wilson auction setting, on the other and, would include the government selling bids of a spectrum of telecommunication. The rules and bids work in opposite ways when the auctioneer is a private entity dealing with a private good (as in the poor man) versus when it is the Government dealing with a public good (like the telecom spectrum). The poor man might attach a lot of private personal value to a painting to push up the price artificially whereas the Government might aim to increase social value by making telecom, telephony and internet services affordable to all socio-economic sections of the population.

The bidders may know exactly what the object’s value is but most often they do not and the auction is characterized by imperfect information. Robert Wilson explained that bidders are most likely to offer less than they think the object or service is worth because they are afraid of overpaying - the winner’s curse. In any negotiation, the winner’s curse sets in when the victory takes away more than it gives, where the bidder overbids for an item due to competitive pressure (or other private factors) and typically pays more than the asset is actually worth. In the same strand of thought, the 2001 Nobel Prize winner, George Akerlof showed how information asymmetry leads to market distortions in the case of used cars (lemons) where the fear of the winner’s curse leads people to bid low. Both Akerlof and Wilson proved that this underbidding to avoid the winner’s curse would be more pronounced with higher levels of imperfect information and uncertainty.

Paul Milgrom, who was Wilson’s graduate student, added that the underbidding would be less in English auctions as compared to Dutch auctions because bidders gain more information about an item’s value during the course of an English auction, since it involves elimination of the lowest bidders during every round of action. With multiple rounds of bidding and eliminations, the bidders gradually gain more information about the object’s true value and the asymmetry tends to subside, and it results in higher revenues.

Dr Sudipa Majumdar is Faculty of Economics at Middlesex University, Dubai

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