<abstract xmlns="http://www.w3.org/1999/xhtml">

<p>This paper attempted using the prospect theory to explain overbidding in first price auctions. The standard outlook in the literature on auctions is that bidders overbid, but the probability weighting functions are nonlinear as in the prospect theory, so they not only tend to underweight the probabilities of winning the auction but also overweight, so that there are overbidders and underbidders. This paper proves that to some extent, non-linear weighting functions do explain overbidding the risk-neutral Nash equilibrium valuation (RNNE). Furthermore, coherent risk measures, such as certainty equivalent and translation invariance, were used to show loss aversion among bidders, and in line with the prospect theory, convexity was also confirmed with sub-additivity, monotonicity and with positive homogeneity.</p>
</abstract>

This paper attempted using the prospect theory to explain overbidding in first price auctions. The standard outlook in the literature on auctions is that bidders overbid, but the probability weighting functions are nonlinear as in the prospect theory, so they not only tend to underweight the probabilities of winning the auction but also overweight, so that there are overbidders and underbidders. This paper proves that to some extent, non-linear weighting functions do explain overbidding the risk-neutral Nash equilibrium valuation (RNNE). Furthermore, coherent risk measures, such as certainty equivalent and translation invariance, were used to show loss aversion among bidders, and in line with the prospect theory, convexity was also confirmed with sub-additivity, monotonicity and with positive homogeneity.

The Prospect Theory and First Price Auctions: an Explanation of Overbidding

Econometrics

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{"article-title":"The Prospect Theory and First Price Auctions: an Explanation of Overbidding"}

This paper attempted using the prospect theory to explain overbidding in first price auctions. The standard outlook in the literature on auctions is that...

The Prospect Theory and First Price Auctions: an Explanation of Overbidding

Published Online: May 30, 2023

Page range: 33 - 74

DOI: https://doi.org/10.15611/eada.2023.1.03

Keywords
cumulative prospect theory, first-price auctions, overbidding, probability weighting function (PWF), inverse S-shaped functions

© 2023 Dushko Josheski et al., published by Sciendo

This work is licensed under the Creative Commons Attribution-ShareAlike 4.0 International License.

The Prospect Theory and First Price Auctions: an Explanation of Overbidding

Published Online: May 30, 2023

Page range: 33 - 74

DOI: https://doi.org/10.15611/eada.2023.1.03

Keywordscumulative prospect theory, first-price auctions, overbidding, probability weighting function (PWF), inverse S-shaped functions

© 2023 Dushko Josheski et al., published by Sciendo

This work is licensed under the Creative Commons Attribution-ShareAlike 4.0 International License.

Keywords
cumulative prospect theory, first-price auctions, overbidding, probability weighting function (PWF), inverse S-shaped functions