The Landscape of Electronic Market Design
Management Science
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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. 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 which a naive bidder matched against a rational bidder does (i) worse than his rational opponent, but (ii) better than a rational bidder matched against another rational bidder. Again, the evolutionary equilibrium contains a strictly positive proportion of naive bidders. The results suggest that overconfident recent entrants in Internet and other low transaction-cost auctions of items that appeal to a mass audience may earn higher payoffs than their experienced competitors and, thus, will not eventually be driven from the market.