Auction Models Are Not Robust When Bidders Make Small Mistakes

September 1999 Economists are generally suspicious of equilibria that are not robust to small perturbations since Agents in real world problems may not be able to perfectly optimize. This research studies two forms of perturbations in a benchmark auction model where firms submit sealed bids to build a single and indivisible public project. First, firms will measure expected payoffs imperfectly and therefore optimize with a small error. Second, firms imperfectly implement their biding strategy, occasionally submitting incorrect bids. Some conclusions in applied work are shown to be extremely sensitive to these two types of perturbations. If the number of bidders is sufficiently large and if a firm cannot compute profit to several significant digits, the Braves-Nash equilibrium is shown not to be robust. If firms implement their bidding strategies with very small error or there is a positive probability that the econometrician misrecords an observed bid, the firms' markups cost will trend to be overestimated in empirical applications. This research proposes a simple model of decision making with error that can be used to alleviate these problems. -->