The Winner's Curse

This post is inspired by Google's aquisition of DoubleClick, in which they outbid Microsoft and others to obtain. There is a well known result of auctions known to economists as "The Winner's Curse," that you would see in an advanced game theory course. This is the idea that we would expect whoever wins the auction probably got a bad deal. Assume that the bidders have similar budget constraints. Prior to going into the auction, each bidder will make estimations about the value of the aquisition (assuming that it's the same for both groups), from which this value would represent the maximum bid. Statistically as a group, we know that on average the bidders would come up with the correct estimate. That is, the bidders will have an equal amount of over- and under- estimation of the true value so that the errors will cancel each other out. However, the winner of the auction will be the bidder who overestimated the true value by the largest amount. It's an interesting idea you should keep in mind with auctions that might fit the assumptions like the Google example above. Another that might work is the Boston Red Sox's bid for the rights to negotiate with Daisuke Matsuzaka.

Update (April 14, 2007): It appears that others believe Google drastically overpaid, supporting my earlier post regarding the Winner's Curse.