UIUC Working Paper No. 00-0118
32 Pages Posted: 7 Apr 2001
Date Written: September 2000
This paper presents an equilibrium explanation for the persistence of naive bidding. Specifically, we consider a common value auction in which a "naive" bidder (who ignores the Winner's Curse) competes against a fully rational bidder (who understands that her rival is not). We show that the naive bidder earns higher equilibrium profits than the rational bidder when the signal distribution is symmetric and unimodal. We then consider a sequence of such auctions with randomly selected participants from a population of naive and rational bidders, with the proportion of bidder types in the population evolving in response to their relative payoffs in the auctions. We show that the evolutionary equilibrium contains a strictly positive proportion of naive bidders. Finally, we consider more general examples. In these examples (i) a naive bidder matched against a rational bidder does worse than his rational opponent but (ii) a naive bidder matched against a rational bidder does better than a rational bidder matched against another rational bidder. Again, the evolutionary equilibrium contains a strictly positive proportion of naive bidders.
Keywords: Bounded Rationality, Bidding, Winner's Curse, Common Value Auctions
JEL Classification: D44
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