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Precautionary Bidding in Auctions

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  • Peter Eso
  • Lucy White

Abstract

We analyze bidding behavior in auctions when risk-averse buyers bid for a good whose value is risky. We show that when the 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 behavior can make DARA bidders prefer bidding in a common values setting to bidding in a private values one when risk-neutral or CARA bidders would be indifferent. Thus the potential for a "winner's curse" can be a blessing for rational DARA bidders. Copyright Econometric Society 2004.

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Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1331.

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Date of creation: Sep 2001
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Handle: RePEc:nwu:cmsems:1331

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