The winner’s curse

Iraq has been auctioning off rights to some of its oil and gas blocks in the last couple of days. Often these big auctions lead to a situation called ‘the winner’s curse’.

The winner’s curse is when the winner of an auction wins the auction but they only win because they have paid too much to win. They are cursed by having bid too high. This can happen in auctions where it is not clear what the item being bid on is worth. The bidders will come up with their own valuation for the item and, most likely, the winner will overvalue it.

A common example is bidding for oil rights, as has been happening in Iraq in the last few days. The companies bidding do not know the value of the oil fields so they have to estimate it based on their knowledge of the geology. There will be a range of guesses as to what it is worth and this will influence their bids. It is likely some of the valuations will be higher than the true value and some will be lower. The winner is ‘cursed’ because they will have the highest valuation but this will be more than the true value.

The more bidders there are, the more likely that someone will overvalue the oil rights and overpay.

The Iraqis do not seem to have understood this as they have made the terms of the deal so restrictive that there were no bids on five out of the six blocks auctioned off so far. The Iraqis were only offering a fixed amount to the winning bidder rather than a profit-sharing arrangement. I’m sure they thought that they were going to do better from not having profit-sharing but in fact they have done worse.

If you run an auction then make sure you maximise the number of bidders to increase the amount that the winner will pay. No-one will be suffering from the winner’s curse if no one bids!

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