Common value auction

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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 has the same value to every participant, although none may know exactly what this value is. Some would call this a pure common value auction, using the term common values to describe any auction in which (i) bidders have different information and (ii) one bidder's information would be informative to another bidder about the latter's valuation for the good. This is sometimes called an interdependent values auction. Using the latter definition, the alternative auction model to a common value auction is a private value auction, where each bidder knows his own valuation of the good, but not the valuations of other bidders.

One important phenomenon occurring in common value auctions is the winner's curse. Bidders have only estimates of the value of the good. If, on average, bidders are estimating correctly, the highest bid will tend to have been placed by someone who overestimated the good's value. This is an example of adverse selection very similar to the classic "lemons" example of Akerlof. Rational bidders will anticipate the adverse selection, so that even though their information will still turn out to have been overly optimistic when they win, they do not pay too much on average.

Sometimes the term winner's curse is used differently, to refer to cases in which naive bidders ignore the adverse selection and bid sufficiently more than a fully rational bidder would that they actually pay more than the good is worth. This is usage is prevalent in the experimental economics literature, in contrast with the theoretical and empirical literatures on auctions.

In a classic example of a pure common values auction used to illustrate the winner's curse, a jar full of quarters is auctioned off. The jar will be worth the same amount to anyone. However, each bidder has a different guess about how many quarters are in the jar. On average, these guesses might be correct, but if the winner is the bidder with the most optimistic guess, his guess will typically be too high.