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Prospect theory in a dynamic game: Theory and evidence from online pay-per-bid Auctions


Brünner, Tobias; Reiner, Jochen; Natter, Martin; Skiera, Bernd (2019). Prospect theory in a dynamic game: Theory and evidence from online pay-per-bid Auctions. Journal of Economic Behavior & Organization, 164:215-234.

Abstract

Abundant evidence exists that expected utility theory does not adequately describe decision making under risk. Although prospect theory is a popular alternative, it is rarely applied in strategic situations in which risk arises through individual interactions. This study fills this research gap by incorporating prospect theory preferences into a dynamic game theoretic model. Using a large field data set from multiple online pay-per-bid auction sites, the authors empirically show that their proposed model with prospect theory preferences makes a better out-of-sample prediction than a corresponding expected utility model. Prospect theory also provides a unified explanation for two behavioral anomalies: average auctioneer revenues above current retail prices and the sunk cost fallacy. The empirical results indicate that bidders are loss averse and overweight small probabilities, such that the expected revenue of the auction exceeds the current retail price by 25.46%. The authors illustrate and empirically confirm a managerial implication for how an auctioneer can increase revenue by changing the details of the auction design.

Abstract

Abundant evidence exists that expected utility theory does not adequately describe decision making under risk. Although prospect theory is a popular alternative, it is rarely applied in strategic situations in which risk arises through individual interactions. This study fills this research gap by incorporating prospect theory preferences into a dynamic game theoretic model. Using a large field data set from multiple online pay-per-bid auction sites, the authors empirically show that their proposed model with prospect theory preferences makes a better out-of-sample prediction than a corresponding expected utility model. Prospect theory also provides a unified explanation for two behavioral anomalies: average auctioneer revenues above current retail prices and the sunk cost fallacy. The empirical results indicate that bidders are loss averse and overweight small probabilities, such that the expected revenue of the auction exceeds the current retail price by 25.46%. The authors illustrate and empirically confirm a managerial implication for how an auctioneer can increase revenue by changing the details of the auction design.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Business Administration
08 Research Priority Programs > Social Networks
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Economics and Econometrics
Social Sciences & Humanities > Organizational Behavior and Human Resource Management
Language:English
Date:2019
Deposited On:21 Aug 2019 09:05
Last Modified:29 Jul 2020 11:09
Publisher:Elsevier
ISSN:0167-2681
OA Status:Closed
Free access at:Publisher DOI. An embargo period may apply.
Publisher DOI:https://doi.org/10.1016/j.jebo.2019.05.032
Other Identification Number:merlin-id:17893

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