Collaborative Research: Investigating Bidding Behavior in Sealed Bid Auctions: Regret, Learning, and Risk Aversion

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Over the past two decades auction theory has been used extensively to help design real world auctions and exchanges. Examples of these new auctions include the FCC auctions for spectrum licenses, electric power auctions, auctions for transportation services, and different types of procurement auctions. These mechanisms are complex, and designers must make decisions about many aspects of auction rules that are likely to have a profound effect on the auction's efficiency, the sellers' revenue and the buyers' profits. Good auction theory is essential if we are to design good auction mechanisms, yet there are important instances in which observed behavior in auctions differs from what would be expected based on auction theory. One important example of this is overbidding (i.e., bidding above the Risk Neutral Nash Equilibrium) observed in Sealed Bid First Price (SBFP) auctions. This result has been replicated many times by different researchers at different laboratories and in a variety of environments, but the reason for overbidding has never been fully understood. Engelbrecht-Wiggans (1989) suggests that participants may overbid in these auctions to avoid feelings of regret. Although the theory of regret has been used to explain some well-known anomalies in expected utility theory, this notion has never been applied to auctions prior to Engelbrecht-Wiggans (1989), and has never been tested in the auction context. The aim of our research is to systematically test the Engelbrecht-Wiggans (1989) theory of regret in auctions in the laboratory, with the specific objective of separating the role of regret from that of risk aversion. As we gain a better understanding of behavior in SBFP auctions, we will also extend and refine the theory to incorporate our new insights and to explain other puzzles involving auctions.