Behavioral finance FAQ / Glossary (Winner's curse)
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The highest bidder's curse shows that
victory has its price.
Hangover after the binge! Whatever the applauses,
Was the cost worth it?
A winner's curse is experienced by the winner of a
contest if the negative effects of the victory supersede
the positive ones.
It is also called a Pyrrhic victory (from Pyrrhus, king of Epire, who said,
just after his army has beaten the Romans in 279 BC, "another victory like
this one, and I'm lost").
The case in finance
Overpaying the ownership bliss.
In finance, any potential buyer normally fight a fierce competition
from other players eager to get hold of the same asset. The winner might
be the one who spent to much in order to get the prey.
This can be the case in:
An auction: the winner has to offer the highest price.
He might ultimately do an extravagant high bidding to succeed.
A take-over, or other kinds of M & A (Mergers & Acquisitions).
An IPO (Initial Public Offering).
Or just market trading on the euphoria of a bubble,
in which to buy leads to accept a delirious price rise.
The incentive is particularly strong if the buyer is driven by his ego
( trophy investment).
This might put him/her into unforeseen trouble as he/she often finds later
that his/her (well, mostly "his", as testosterone is often involved)
exuberance, or arrogance, made him/her overpay the desired shiny
The fake happy end hides in fact an "heroic failure", maybe a "kiss
What can make a winner fall in his own trap?
Overvaluing its prey or prize
The winner might have deluded himself because of:
Cognitive biases such as overconfidence, illusion of competence,
magical thinking, naivety, availability heuristic, framing,
Some routine and habit also, getting mentally lazy after many
successes without questioning the strategy.
Emotional biases such as greed, excitation,
herding, overconfidence or pure hubris,
Buckets of testosterone and dopamine can win the fight...
...and generate bruises.
But also difficulties and imprecision (or even
asymmetries of information) to evaluate the deal.
Even if the average biddings are circling the "normal" value, the
winner, as he/she is the highest bidder, could have overvalued the
asset even after using rational criteria.
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