Tuesday, November 04, 2008

Neuroeconomics - the neural circuitry of overbidding

Delgado et al. offer an interesting article in Science Magazine suggesting that fear of loss may mediate overbidding in auctions. Here is their abstract, followed by comments in a review by Maskin.
We take advantage of our knowledge of the neural circuitry of reward to investigate a puzzling economic phenomenon: Why do people overbid in auctions? Using functional magnetic resonance imaging (fMRI), we observed that the social competition inherent in an auction results in a more pronounced blood oxygen level–dependent (BOLD) response to loss in the striatum, with greater overbidding correlated with the magnitude of this response. Leveraging these neuroimaging results, we design a behavioral experiment that demonstrates that framing an experimental auction to emphasize loss increases overbidding. These results highlight a role for the contemplation of loss in understanding the tendency to bid "too high." Current economic theories suggest overbidding may result from either "joy of winning" or risk aversion. By combining neuroeconomic and behavioral economic techniques, we find that another factor, namely loss contemplation in a social context, may mediate overbidding in auctions.
Maskin's comments are based on followup experiments not mentioned in the abstract:
The fMRI data show that subjects experience a lower blood oxygen level in the striatum in response to losing an auction, but no significant change in reaction to winning one. The authors interpret this result as suggesting that subjects experience "fear of losing" and that this fear accounts for their overbidding. But actually modeling fear explicitly--making it precise--does not seem straightforward.

A natural modeling device would be simply to subtract something from the subject's payoff when she loses. However, such a modification would not accord with the authors' findings in their subsequent experiment. In the follow-up, there were two treatments: one in which a subject is initially given a bonus sum of money S but told that she has to return it if she loses the auction; the other in which the subject is promised that if she wins she will get S. The two treatments are, ex post, identical: In both cases, the subject ends up with the bonus if and only if she wins. However, in practice, subjects bid more in the former treatment than the latter. Such behavior sharply contradicts the "payment subtraction" hypothesis, under which behavior in the two treatments would be the same. Moreover, it seems difficult to find a natural alternative formulation of the "fear of losing" idea that explains the results simultaneously from both Delgado et al. experiments. Even so, there is a well-known principle that could account for the behavioral discrepancy between the two treatments in the follow-up experiment: the "endowment" effect. When a subject is given a bonus S at the outset, she may become possessive and so move more aggressively to retain it than she would act to obtain a contingent bonus at the end of the experiment.

As for why subjects overbid, perhaps the answer is that high-bid auctions are just too complex for a typical buyer to analyze completely systematically. The buyer will easily see that she has to shade her bid (bid strictly below v) to get a positive payoff. Still, she won't want to shade too much because shading reduces her probability of winning. A simple rule of thumb would be to shade just a little. But this leads immediately to overbidding, because risk-neutral equilibrium bidding entails a great deal of shading: A buyer will bid only one-half her valuation.

1 comment:

  1. Anonymous4:13 AM

    Maskin says that Delgado et al are not clear about their hypothesis and that their follow up experiment is not consistent with "fear of losing". However, I think that their follow up experiment showed quite clearly that when there is a framed loss, the overbidding tends to be more exaggerated.

    In fact, I think it is Maskin who is unclear. I don't quite understand Maskin's "payment subtraction" hyphothesis and how it helps to model fear of losing. Can someone please explain?