Winner's curse

The winner's curse is the tendency for winning bidders (in an auction) to over-pay.

In a situation where there are a number of bidders, and each bidder makes a bid based on their estimate of the value, then the most optimistic will win.

However, the most optimistic is also the one who is most likely to have over-estimated the value. Therefore it is highly likely that the winner overpaid.

The most widely cited example is in bidding for drilling rights for oil, but it has been found in areas as far apart as IPOs (for certain mechanism) and labour markets. Analogous effects have been found even in scientific publishing.

Because bidders are aware of winner's curse, attempts to compensate for winner's curse can further distort markets: this can lead to strange effects such as more competition increasing prices.

Apart from bidder's own attempts to adjust (e.g., by bidding at less than their estimate, leaving a margin for error), winner's curse can be reduced by better information, or by more complex price setting mechanisms than simply using the level of the winning bid.