Separating probability weighting and risk aversion in first-price auctions

• Published in: Economics letters Vol. 221; p. 110891
• Main Authors: Haruvy, Ernan, Heinrich, Timo, Walker, Matthew J.
• Format: Journal Article
• Language: English
• Published: Elsevier B.V 01.12.2022
• Subjects: Bias; Experiment; First-price auctions; Probability weighting; Risk aversion; Risk aversion; First-price auctions; C57; Bias; Experiment; C91; Probability weighting; D81
• ISSN: 0165-1765; 1873-7374
• DOI: 10.1016/j.econlet.2022.110891

In first price sealed-bid auctions, a power probability weighting function is observationally equivalent to a model with constant relative risk aversion. By comparing auctions with different ceilings on a computerized opponent’s bid space, we can separate inverse S-shaped probability weighting as commonly used in the literature and risk-averse preferences from the distribution of observed bids. We find evidence to support both theories in the data. However, we also observe a significant number of violations after accounting for decision noise, which suggest that bidders’ valuations may be malleable to cues of the auction environment. •We design an experiment to separate probability weighting and risk-aversion in bidding.•We vary the beliefs about the opponent without changing the risk neutral optimal bid.•We find evidence to support both probability weighting and risk aversion in the data.•We observe a significant number of violations of both probability weighting and risk aversion.•We find that bidders’ valuations may be malleable to cues of the auction environment.