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Bidding for an Item of Unknown Value

Bidding for an Item of Unknown Value. 1. The item you see will be won by the highest sealed bid . Write down your: 1) best value estimate, 2) lower and upper estimate bounds, and 3) optimal sealed bid. Now let’s quickly explore the cross section

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Bidding for an Item of Unknown Value

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  1. Bidding for an Item of Unknown Value 1 The item you see will be won by the highest sealed bid. Write down your: 1) best value estimate, 2) lower and upper estimate bounds, and 3) optimal sealed bid. Now let’s quickly explore the cross section (i.e. distribution) of estimates and bids.

  2. 2 BIDDING (continued) Bid Distribution Estimate Distribution w w w w _ B V All bidders discount bids below their estimates. Nonetheless, when the value of the item is highly uncertain, a winning bid (drawn from the right tail) will exceed the true value of the item.

  3. 3 Pitfalls in Assessing Risks The proper “language” of uncertainty is PROBABILITY. But even those fluent in the language (statisticians, actuaries) can unknowingly fall prey to systematic errors and biases in risk assessment. 1. Self-serving Biases and Wishful Thinking Or how preferences can cause biases in risk assessments. Two experiments. Shell Oil’s Mispredictions.

  4. More Pitfalls 4 2. Status Quo Biases Or the psychology of clinging to “old” beliefs. The weather tomorrow will be like the weather today. Example: Scientific beliefs. Sighting Uranus.

  5. More Pitfalls Possible Values under T | | | | | | $0 20 40 60 80 100 $0 20 40 60 80 100 120 150 | | | | | | | | Possible Values under A 5 3. Acquiring a Company Firm A will make a cash tender offer for Firm T. However, T’s value is highly uncertain ranging from $0 to $100 per share. T knows its own true value. Due to synergies, the firm is worth 50% more under A’s management and control.

  6. 6 Acquiring a Company (continued) What is A’s most profitable bid for T? Most respondents (72%) offer between $51 and $71 per share. But once again all these offers fall prey to the WINNER’S CURSE! If A offers $50 per share, only “low-value” ($0 - $50) firms accept. The average value of such firms is $25 under T and still only $37.5 per share under A. Firm A gets less than it paid for!

  7. More Pitfalls Wear None Total T > 65 3 T < 65 4 Total 7 3 2 53 57 58 63 70 75 7 4. The 1986 Challenger Disaster Results for all 30 Launches? Should NASA have foreseen the risk of O-Ring failure during a low-temperature launch? 23 26 0 4 23 30 There had been O-Ring wear in 7 of the 30 prior launches at the following temperatures: Is O-Ring wear correlated with low temperatures?

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