Working Paper: CEPR ID: DP3975
Authors: Pter Es; Lucy White
Abstract: We analyse bidding behaviour in auctions when risk-averse buyers bid for a good whose value is risky. We show that when 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 behaviour can make DARA bidders prefer to bid in a common values setting than a private values one when a risk-neutral or CARA bidder would be indifferent. Thus the potential for a ?winners curse? can be a blessing for rational DARA bidders.
Keywords: English Auctions; First-Price Auctions; Prudence; Risk; Risk Aversion; Second-Price Auctions; Winners Curse
JEL Codes: D44; D81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased risk (D81) | decreased bids (D44) |
| increased risk (D81) | higher expected utility (D11) |
| risk-averse buyers (DARA) (D81) | reduced bids (D44) |
| reduced bids (D44) | higher expected utility (D11) |
| pure risk added to valuations (G19) | reduced bids (D44) |
| DARA preferences (Y10) | precautionary bidding effect (D44) |