Are the Vickrey Auction and the BDM Mechanism Really Incentive Compatible? - Empirical Results and Optimal Bidding Strategies in Cases of Uncertain Willingness-to-pay

Willingness-to-pay (WTP) data elicited with the help of incentive compatible methods like the Vickrey auction and the BDM mechanism promise higher validity than stated preferences data and provide more information content than do revealed-preferences data. However, research shows that subjects in a Vickrey auction do not always follow the dominant strategy of bidding their WTP, but frequently bid too high or too low. Although this phenomenon is usually attributed to irrational behavior, that need not be the only explanation. In marketing research applications, subjects are typically asked their WTP for a new product, and it appears that most subjects are uncertain about their exact WTP. We present a modified bidding model to explain that in this case, it is optimal for risk-averse but rational bidders to underestimate, rather than to overestimate, their WTP. The model is supported by preliminary experimental data.