ACADEMIC ARTICLE SUMMARY
The Affiliation Effect in First-Price Auctions
Article Source: Econometrica, Vol. 73, No. 1, pp. 263-277, 2005
Publication Date:Time to Read: 2 minute read
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This paper considers a novel feature of bidding processes in a type of auction called affiliated private value auctions.
In auctions where the item is sold to the highest bidder at the highest bid, it is difficult to distinguish between common value and private value auctions using bid data.
- Auctions have been thoroughly scrutinized by economists.
- In a private value auction, each bidder knows how much she truly values the object being auctioned but is unsure how other bidders value it. This is distinct from a common value auction, where each bidder has a guess of the object’s value but none of them are certain they are correct.
- Sometimes a bidder’s valuation may be high because an object is valuable to everyone or because the object is particularly valuable to the bidder. This kind of auction is called affiliated.
- When an auction is first-price, the highest bidder gets the object, and pays her bid exactly. First-price auctions may be common value or private value.
- In a first-price affiliated private value auction, bidders who value the object highly realize they likely value the object more highly than other bidders, and revise their bid downward: they know they are still likely to win and get away with paying less to the auctioneer. This is called the affiliation effect.
- A rough example: if an auctioneer is offering my great-grandfather’s pocketwatch to a room full of bidders, I might bid much less than the heirloom’s true value to me. Unless the room is full of my grandfather’s other descendents, I should be able to win the pocketwatch paying a low price.
- Under these conditions, it is possible for bidders in an auction to bid less as more bidders participate in the auction. This is a novel and counterintuitive result.
- In common price auctions, bidders are uncertain what an auctioned object is worth, but all of them have guesses about its true value. If a bidder with a high valuation guess does not adjust his bid downward, he is likely to win the auction but receive an object worth less than he paid. This phenomenon is called the Winner’s Curse and closely resembles the affiliation effect. Consequently it is difficult to use bid data to determine whether a first-price auction is of the common value or private value type.