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Auctions with Loss Averse Bidders

Eisenhuth, Roland and Ewers, Mara (2010): Auctions with Loss Averse Bidders.

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We theoretically and experimentally study independent private value auctions in the presence of bidders who are loss averse in the sense of Köszegi and Rabin (2007). In one specification, we consider gains and losses in two dimensions separately, about whether they receive the object or not, and how much they pay (narrow bracketing of gains and losses); in the other specification, we consider gains and losses over the entire risk neutral pay off, i.e. the valuation less the bid (wide bracketing of gains and losses). With wide bracketing, we show that the expected revenue for the auctioneer is higher in the first price auction than in the all pay auction, and with narrow bracketing, we show that the opposite is true for the revenue ranking between the first price auction and the all pay auction. In order to test the theoretical predictions, we conduct laboratory experiments, in which money and a real object is auctioned in both a first price auction and an all pay auction. In both settings, the average revenue is significantly higher in the first price auction, suggesting that bidders may behave according to the one dimensional model, although a real object is auctioned. Whereas our findings are inconsistent with narrow bracketing of gains and losses, they are consistent with wide bracketing of gains and losses.

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