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Unformatted text preview: Econ 196 Topic: Behavioral Economics Quasi-Endowment in Private-Value Auctions Introduction The analysis of symmetric, private-value auctions pioneered by Vickrey (1961) and Myerson (1981) assumes bidders are risk neutral, a crucial assumption upon which the famous revenue- equivalence principle relies. However, despite their elegance, these models have seen little empirical validation. Neither these models nor subsequent extensions to the case of risk-averse bidders have been able to account for overbidding in auctions, a phenomenon widely documented in empirical research. Overbidding in auctions has long been an object of interest, even to non-economists. For instance, most are familiar with the colloquial explanation of overbidding known as auction fever, which holds that bidders become emotionally caught up in the bidding process. One of the more novel explanations for overbidding was recently proposed by Ariely et al (2004). They provide experimental evidence for a quasi-endowment effect, whereby bidders develop a sense of attachment to the object during the bidding process and come to see the object as an item that already belongs to them. This suggests that bidders influenced by this effect would bid higher than they otherwise would have, in order to retain what they perceive as an endowment. This result confounds most of the theoretical literature on auctions, under which no such behavior should occur. In this literature, auctions are modeled as games of imperfect information, and bidders are assumed to be rational, their strategies dictated by the games Bayesian-Nash equilibrium. In particular, the payoff for a particular bidder is assumed to be a function of only the value of the object and the expected payment, the function linear for the case of risk neutrality and concave for risk aversion. This paper departs from the literature on auctions first by incorporating loss aversion into specifications of bidder utility. In doing so, we provide some theoretical basis for the quasi- endowment effect, which can be framed as loss aversion. For first- and second-price auctions, 1 1 In a first-price auction, the winner pays the highest bid (her bid). In a second-price auction, the winner pays the second-highest bid. English auctions are the familiar oral auctions in which an auctioneer calls out ascending prices, and bidders signal their willingness to pay. we present equilibrium bidding strategies for a fixed, exogenous reference point. We also extend the revenue-equivalence principle to bidders with loss aversion and thus determine the expected payment of such bidders for a wide class of auction formats. We next attempt to incorporate some of the insights from the empirical research on quasi- endowment in dynamic auctions into two models of English auctions. One model follows the standard model of Milgrom and Weber (MW) (1982) for interdependent-value auctions, and the second employs an alternating recognition (AR) model developed by Harstad and Rothkopf...
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