Bid shading
Encyclopedia
In an auction
, bid shading describes the practice of a bidder placing a bid that is below what they believe a good is worth.
Bid shading is used for one of two purposes. In a common value auction
with incomplete information, bid shading is used to compensate for the winner's curse
. In such auctions, the good is worth the same amount to all bidders, but bidders don't know the value of the good and must independently estimate it. Since all bidders value the good equally, the winner will generally be the bidder whose estimate of the value is largest. But if we assume that in general bidders estimate the value accurately, then the highest bidder has overestimated the good's value and will end up paying more than it is worth. In other words, winning the auction carries bad news about a bidder's value estimate. A savvy bidder will anticipate this, and reduce their bid accordingly.
Bid shading is also used in First-price Auctions, where the winning bidder pays the amount of his bid. If a participant bids an amount equal to their value for the good, they would gain nothing by winning the auction, since they are indifferent between the money and the good. Bidders will optimize
their expected value
by accepting a lower chance of winning in return for a higher payoff if they win.
In a first-price common value auction, a savvy bidder should shade for both of the above purposes.
Auction
An auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder...
, bid shading describes the practice of a bidder placing a bid that is below what they believe a good is worth.
Bid shading is used for one of two purposes. In a common value auction
Common value auction
A common value auction is a term in economics used to describe an environment in which information about the value of the object for sale is dispersed among bidders. The term is used in different ways by different people. By one definition it describes an auction in which the good being auctioned...
with incomplete information, bid shading is used to compensate for the winner's curse
Winner's curse
The winner's curse is a phenomenon akin to a Pyrrhic victory that occurs in common value auctions with incomplete information. In short, the winner's curse says that in such an auction, the winner will tend to overpay...
. In such auctions, the good is worth the same amount to all bidders, but bidders don't know the value of the good and must independently estimate it. Since all bidders value the good equally, the winner will generally be the bidder whose estimate of the value is largest. But if we assume that in general bidders estimate the value accurately, then the highest bidder has overestimated the good's value and will end up paying more than it is worth. In other words, winning the auction carries bad news about a bidder's value estimate. A savvy bidder will anticipate this, and reduce their bid accordingly.
Bid shading is also used in First-price Auctions, where the winning bidder pays the amount of his bid. If a participant bids an amount equal to their value for the good, they would gain nothing by winning the auction, since they are indifferent between the money and the good. Bidders will optimize
Optimization (mathematics)
In mathematics, computational science, or management science, mathematical optimization refers to the selection of a best element from some set of available alternatives....
their expected value
Expected value
In probability theory, the expected value of a random variable is the weighted average of all possible values that this random variable can take on...
by accepting a lower chance of winning in return for a higher payoff if they win.
In a first-price common value auction, a savvy bidder should shade for both of the above purposes.