Winner's Curse

Definition of 'Winner's Curse'


A tendency for the winning bid in an auction to exceed the intrinsic value of the item purchased. Because of incomplete information, emotions or any other number of factors regarding the item being auctioned, bidders can have a difficult time determining the item's intrinsic value. As a result, the largest overestimation of an item's value ends up winning the auction.

Originally, the term was coined as a result of companies bidding for offshore oil drilling rights in the Gulf of Mexico. In the investing world, the term often applies to initial public offerings.

Investopedia explains 'Winner's Curse'


For example, say Jim's Oil, Joe's Exploration and Frank's Drilling are all courting drilling rights for a specific area. Let's suppose that, after accounting for all drilling-related costs and future potential revenues, the drilling rights have an intrinsic value of $4 million. Now let's suppose that Jim's Oil bids $2 million for the rights, Joe's Exploration $5 million and Frank's Drilling $7 million. While Frank's won the auction, it ended up overpaying by $3 million. Even if Joe's Exploration is 100% sure that this price is too high, it can do nothing about it, as the highest bid always wins the auction, no matter how overpriced the bid may be.

As intrinsic value is subjective, situations aren't so clear-cut in real life. Theoretically, if perfect information was available to everyone and all participants were completely rational in their decisions and skilled at valuation, no overpayments would occur. However, in the same way that bubbles in the stock or real estate markets are created, people tend to be irrational and push prices beyond the true values of the assets involved.



comments powered by Disqus
Hot Definitions
  1. Benchmark Bond

    A bond that provides a standard against which the performance of other bonds can be measured. Government bonds are almost always used as benchmark bonds. Also referred to as "benchmark issue" or "bellwether issue".
  2. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to sales or total asset figures.
  3. Oil Reserves

    An estimate of the amount of crude oil located in a particular economic region. Oil reserves must have the potential of being extracted under current technological constraints. For example, if oil pools are located at unattainable depths, they would not be considered part of the nation's reserves.
  4. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  5. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  6. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
Trading Center