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Loss Aversion in Sequential Auctions: Endogenous Interdependence, Informational Externalities and the "Afternoon Effect"

Rosato, Antonio (2014): Loss Aversion in Sequential Auctions: Endogenous Interdependence, Informational Externalities and the "Afternoon Effect".

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Abstract

Empirical evidence from sequential auctions shows that prices of identical goods tend to decline between rounds. In this paper, I show how expectations-based reference-dependent preferences and loss aversion can rationalize this phenomenon. I analyze two-round sealed-bid auctions with symmetric bidders having independent private values and unit demand. Equilibrium bids in the second round are history-dependent and subject to a "discouragement effect": the higher the winning bid in the first auction is, the less aggressive the behavior of the remaining bidders in the second auction. When choosing his strategy in the first round, however, a bidder conditions his bid on being pivotal and hence expects not to be discouraged. Equilibrium behavior, therefore, leads the winner of the first round to overestimate the bid of his highest opponent and hence the next-round price so that equilibrium prices decline. Moreover, sequential and simultaneous auctions are not bidder-payoff equivalent nor revenue equivalent.

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