Explaining Overbidding in First Price Auctions Using Controlled Lotteries∗

In this paper, we study the behavior of individuals when facing two different, but incentive-wise identical, institutions. We pair the first price auction with an equivalent lottery. Once a subject is assigned a value for the auctioned object, the first price auction can be modeled as a lottery in which the individual faces a given probability of winning a certain payoff. This set up allows us to explore to what extent the misperception of the probability of winning in the auction is responsible for bidders in a first price auction to bidding above the risk neutral Nash equilibrium prediction. The first result we obtain is that individuals, even though facing the same choice over ∗We thank Michael Reksulak for excellent research assistance. Financial support from the Office of Naval Research, and the Hearin Foundation is gratefully acknowledged. Laura Razzolini also acknowledges financial support from the National Science Foundation, grant SBR-9973731. We wish to thank John Conlon, Jim Cox, Ron Harstad, John Kagel, Bob Reilly, James Walker, and two anonymous referees for helpful comments and suggestions. Any remaining errors are ours. The views expressed in this paper are the authors’ and do not necessarily represent those of the National Science Foundation. Address: Department of Economics, The University of Mississippi, University, MS 38677. Fax: (662) 915-5821. Email: [email protected]