What Is the Champ’s Curse?
The winner’s curse is a tendency for the winning bid in an auction to exceed the intrinsic value or true worth of an item. The gap in auctioned vs. fundamental value can typically be attributed to incomplete information, bidders, emotions, or a variety of other subjective factors which can connections bidders. In general, subjective factors usually create a value gap because the bidder faces a difficult time ascertaining and rationalizing an item’s true intrinsic value. As a result, the largest overestimation of an item’s value ends up winning the auction.
The conquering hero’s curse can lead to an example of buyer’s remorse, wherein the buyer of something feels like they’ve overpaid in reconsideration.
Understanding the Winner’s Curse
Originally, the term winner’s curse was coined as a result of companies bidding for offshore oil discipline rights in the Gulf of Mexico. In the investing world, the term often applies to
An Example of the Winner’s Curse
For example, say Jim’s Oil, Joe’s Investigation, and Frank’s Drilling are all courting drilling rights for a specific area. Let’s suppose that, after accounting for all drilling-related costs and concealed future revenues, the drilling rights have an intrinsic value of $4 million. Now let’s suppose that Jim’s Oil bids $2 million for the rights, Joe’s Review $5 million, and Frank’s Drilling $7 million.
While Frank’s won the auction, it ended up overpaying by $3 million. All the more if Joe’s Exploration is 100% sure that this price is too high, it can do nothing about it, as the highest bid always wins the auction, no context how overpriced the bid may be.