The “winner’s curse” is an economic concept that refers to the fact that the winning bidder in a competitive auction often overpays. This phenomenon occurs even when the bidders have expertise with respect to the value of the item being auctioned.
For example, assume a 1959 Ford Thunderbird is auctioned off and there are 100 car enthusiasts at the auction. All the bidders know the general range of what such a car is worth, but 1959 Thunderbirds are relatively rare and each car has its own idiosyncrasies. The bidding begins at $25,000 and 10 people actively bid on the car. As the bids work their way to over $50,000 the number of active bidders drop to just two. The two bidders trade bids until finally the car sells for $59,000. Has the winning bidder overpaid?
Arguably, yes he has. The exact value for a relatively rare car is not knowable, but there were ten active bidders and nine of the ten decided that the car was not worth $59,000. Only the winning bidder thought it was worth that amount. If the “winner” tried to sell the car for $59,000 the next day among the 100 car enthusiasts who were at the auction he’d be unlikely to get such a price. Thus, the winning price at an auction often establishes the high end of the range of value.
The winner’s curse can occur anytime there is a competitive bidding process: artwork, “hot” houses on the market, classic cars, eBay auctions and IPOs structured as auctions.