Game of Auctions and Winner’s Curse

Did Vijay Mallya overpay during IPL auction? Is Yuvraj Singh really worth Rs.14 crores? I am sure, post auction; Vijay Mallya is suffering from “winner’s curse”- common phenomenon in game of auctions. After auction Vijay Mallya tweeted that he had overpaid by few crores! I am sure few crores mean a lot to employees of his bankrupt airline company.

mallya

There are various types of auctions, most common is English auction. In English auction, participants bid openly against one another, with each subsequent bid required to be higher than the previous bid. The auction ends when no participant is willing to bid further, at which point the highest bidder pays his bid.

The auctioned item is of roughly equal value to all bidders i.e. value of Yuvraj Singh or Virat Kohli is same for any of the IPL teams, but the bidders don’t know the player’s market value when they bid esp. how he will perform in IPL matches. Each bidder independently estimates the value of the player before bidding. The winner of an auction is the bidder who submits the highest bid. If we assume that the average bid is accurate, then the highest bidder overestimates the player’s value. Thus, the auction’s winner is likely to overpay, also known as winner’s curse.

The term winner’s curse was first coined in 1950’s; during that period there was no accurate method to estimate the potential value of an offshore oil field. For example if an oil field had an actual intrinsic value of $20 million, oil companies might guess its value to be anywhere from $10 million to $30 million. The company who wrongly estimated at $30 million and placed a bid at that level would win the auction, and later find that it was not worth as much- loss of $ 10 million, in other words winner’s curse. In fact average bid was more accurate.

Why leads to overpaying? One of the reason is hubris- excessive arrogance or confidence, which leads a person to believe that he cannot do anything wrong.

Vijay Mallya is known for his flamboyant lifestyle, so it is likely that hubris led to winner’s curse.

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