winner's curse

Winner's Curse

A financial theory that the winning participants within an auction will typically pay an overvalued price for the winning item.

Notes:

The problem of the winner's curse occurs during any auction process when bidders must estimate the true or final value of a desired good. Generally, bidders are considered to be risk averse and the average bid is expected to be lower than the final value. However, due to estimation errors, the winning bid is usually much higher because the highest overestimation made by any of the bidders will win the auction.

The significance of this theory is most evident in IPO pricing schemes. Because this observation contradicts the common assumption of rational investors, it allows underwriters to price new issues differently.

See also: Behavioral Economics, Behavioral Finance, Dutch Auction, IPO, Risk Averse, Underwriting

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Winner's curse

Problem faced by uninformed bidders. For example, in an initial public offering uninformed participants are likely to receive larger allotments of issues that informed participants know are overpriced.

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winner's curse

The likelihood the winning bidder in an auction of several bidders will pay too high a price. From an investor's standpoint, the winner's curse implies the stockholders of the firm acquired in a merger will benefit at the expense of the stockholders of the acquiring firm when several potential acquirers are involved in the bidding.