The Winner's Curse : Conditional Reasoning and Belief Formation

In explaining the winner’s curse, recent approaches have focused on one of two cognitive processes: conditional reasoning and belief formation. We provide the first joint experimental analysis of the role of these two obstacles. First, we observe that overbidding decreases significantly between a simple common-value auction and a transformed version of this auction that does not require conditional reasoning. Second, assistance in belief formation leads to comparable behavioral changes in both games. The two effects are of similar magnitude and amplify each other when jointly present. We conclude that the combination and the interaction of the two cognitive processes in auctions lead to relatively low strategic sophistication compared to other domains. The study’s focus on games’ objective cognitive challenges is potentially useful for predictions across games and complements the common focus on behavioral models and their explanatory power