The Origin of the Winner's Curse: A Laboratory Study

Abstract

The Winner's Curse (WC) is a robust and persistent deviation from theoretical predictions established in experimental economics and claimed to exist in field environments. Recent attempts to reconcile such deviation include “cursed equilibrium” and level-k reasoning. We design and implement a simplified version of the Acquiring-a-Company game that transformed the game to an individual-choice problem that still retains the adverse-selection problem. We further simplified the problem so that simple ordinal reasoning could replace both Bayesian updating and contingent thinking. Our results suggest that the WC reflects bounded rationality in that people have difficulties performing contingent reasoning on future events. (JEL D81, D82)