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Winner's Curse Corrections Magnify Adverse Selection

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Abstract

The adverse-selection literature has only considered the case in which competing sellers' costs of supply are independent and privately known by the individual sellers. In contrast, the auction literature has ignored adverse selection by implicitly assuming that a bid-taker is indifferent between suppliers at a given price. We show that competition in auctions with common-value elements serves to magnify the impact of adverse selection, as a bidder supplying a higher-cost product rationally makes a heightened winner's curse correction in a procurement auction. Hence lower-cost suppliers are disproportionately likely to win the auction, potentially creating a more serious quality problem for the procurer than mainstream adverse-selection models suggest.

Suggested Citation

  • Ronald M. Harstad & Robert Bordley, 2009. "Winner's Curse Corrections Magnify Adverse Selection," Working Papers 0907, Department of Economics, University of Missouri.
  • Handle: RePEc:umc:wpaper:0907
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    File URL: https://economics.missouri.edu/working-papers/2009/wp0907_harstad.pdf
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    Keywords

    winner's curse; adverse selection; common-value auctions; procurement; product quality;

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium

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