What are some of the pitfalls and concerns with regard to bidding on properties in a volatile market?Winner’s curse dialogue: “Congratulations, you won the deal. Too bad! You won the deal.” The market continues to heat up. Here is some advice for aggressive managers seeking to increase AUM . . .fast. Bidders make systematic errors due to greater market uncertainty and a large field of competing bidders. The way to avoid the winner’s curse is to reduce a bid to some estimated value fraction, the optimal value of which declines with market volatility and the number of bidders. Unfortunately, by reducing a bid, the anxious investor decreases the likelihood of winning auctions. Investors may decide not to bid at all, which is a choice that over the last two years has resulted in historically low transactions volume, extensive layoffs across all economic sectors as sellers and buyers have retreated to the sidelines. Alternatively, the investor may succeed is exploiting certain informational or first mover advantages, thereby changing the odds favorably.
Controlled laboratory experiments as well as casual empiricism confirm that auction participants fail to adapt their bidding strategy according to competitive models; their behavior is suboptimal. This failure is systematic and seemingly continual, as if there were no learning process. We ask, do market participants have the incentive and ability to adjust their behavior to informational complexities? If pricing is the outcome of a flawed bidding process, what can we make of appraisals and comparable sales data, especially when transactions volume is low?
It is clearly an empirical question whether or not the winner’s curse dominates. We believe that the winner’s curse is a real risk today, especially in real estate markets whose chief characteristic is hidden, asymmetric information.
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