Getting it right or getting it cursed: Auction prices in a residential real estate bubble

• Published date: 01 November 2019
• Date: 01 November 2019
• DOI: http://doi.org/10.1111/eufm.12200

DOI: 10.1111/eufm.12200

ORIGINAL ARTICLE

Getting it right or getting it cursed: Auction prices

in a residential real estate bubble

Clare Branigan

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Cal Muckley

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Paul Ryan

UCD College of Business, University

College Dublin, Belfield, Dublin 4, Ireland

Emails: clare.branigan@ucd.ie;

cal.muckley@ucd.ie; paul.ryan@ucd.ie

Funding information

Science Foundation Ireland, Grant number:

16/SPP/3347

Abstract

This is the first study to test for a winner's curse in a bubble

market. Our hand-collected sample comprises the sequence

of bids and the experience of the winning bidder at Irish

residential real estate auctions, prior to the collapse of the

bubble. Portfolios of practitioner- and hedonic pricing model-

selected self-similar properties provide benchmark property

price estimates. We show neither real estate investors nor

owner occupiers shade auction bids to avoid the winner's

curse and both raise bids in line with competition. Winning

investor bidders pay more for properties, ride the wave of a

property bubble, and potentially exacerbate it.

KEYWORDS

bubbles, owner occupier, professional investor, residential real estate,

winner's curse

JEL CLASSIFICATION

G00, G01, G02, G10, R31

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INTRODUCTION

This is the first study to test for a winner's curse in an auction setting in a bubble market. We examine, in

agrowth-of-bubble setting, the formulation of bidding strategies of winning bidders in real estate

The authors thank John Doukas (the Editor), two anonymous referees, Utpal Bhattacharya, Réne Stulz, and Richard Taffler

for their insightful comments. This paper has also benefited from comments made by participants at the European Real

Estate Society Annual Conference in Bucharest in June 2014, the Behavioural Finance Working Group Annual Conference

in Queen Mary College, University of London, June 2014, and the Chartered Financial Analysts (CFA) Program Partners

Conference in the University of Southern California in July 2014. Cal Muckley would like to acknowledge the financial

support of Science Foundation Ireland under Grant Number 16/SPP/3347. The usual disclaimer applies.

Eur Financ Manag. 2018;1–29. wileyonlinelibrary.com/journal/eufm © 2018 John Wiley & Sons, Ltd.

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1121Eur Financ Manag. 2019;25:1121–1149. wileyonlinelibrary.com/journal/eufm © 2018 John Wiley & Sons, Ltd.

auctions. That momentum (Case & Shiller, 1988), mean reversion (Cutler, Poterba, & Summers,

1991), and excess variance relative to fundamentals (Glaeser, Gyourko, Morales, & Nathanson, 2014)

characterize metropolitan area real estate housing prices is well known. And that, there are far-reaching

and material implications of a convulsive real estate market for the real economy (Brocker & Hanes,

2014), via firm-level investment (Gan, 2007) and the financial sector (Gorton & Metrick, 2012), are a

matter of major concern. There is, however, scant field evidence, in this critically important growth-of-

bubble market phase, in regard to the factors which persuade these real estate bidders to bid high. We

aim, by availing of a unique, hand-collected and insightful data set of Dublin residential real estate

English open-bid outcry auctions, to characterize winning bidder strategies in this market.

A winner's curse occurs in auctions when a successful bidder finds that she has paid too much for an

item due to suboptimal trading behavior. As the range of auctioned asset value estimates and bids

increases (i.e., in line with uncertainty in the auctioned asset and the number of bidders) across auction

participants, the winning bidder will overestimate the true value (i.e., the average bid) of the auctioned

asset, overbid, and, hence, experience the winner's curse. To mitigate the winner's curse, in a first price

sealed-bid common value auction, optimal (rational) trading behavior implies bids which vary

inversely (so-called bid shading) with the uncertainty in the value of the asset under auction (Bazerman

& Samuelson, 1983) and with the level of competition between the bidders (Kagel & Levin, 1986).

Exposure to the winner's curse is, however, attenuated in English open-bid outcry auctions (Levin,

Kagel, & Richard, 1996): open-bidding, especially by a large number of bidders, reduces uncertainty

by imparting information which the bidders can use to update their estimates of value. This reduction in

uncertainty, in the auctioned asset, markedly diminishes the likelihood of a winner's curse. A related

behavioral argument, alluded to in Cramton (1998), suggests that, in these ascending bid auctions,

winning bids can be expected to vary positively in association with competition due to the ‘comfort

afforded’ to the bidder that it is not necessary, to win, to overbid by more than one bid increment.

Auctioned asset price uncertainty implies, in the same vein, that others can still be expected to pay

more, prior to the resolution of the auction, than the subsequent bid and that this can be reassuring for

the marginal bidder – when formulating, what turns out to be, the winning bid. As a result, in English

open-bid outcry auctions, we expect a positive relation between the winning bid prices and competition

and auctioned asset price uncertainty, to be a characterizing feature of winning bidder strategies.

The issue of whether there is a winner's curse prevalent in auction markets is contentious. While

Davis and Holt (1993) and Kagel and Levin (2002) use laboratory experiments which show bidders

falling victim to the winner's curse, empirical tests in field settings report both no evidence of a winner's

curse (Boone & Mulherin, 2008; Hendricks & Porter, 1987; Thiel, 1988) and, in a variety of auction

settings, evidence of this phenomenon (Roll, 1986; Veraiya, 1988). In the corporate takeover market,

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for instance, Roll (1986) and Veraiya (1988) find evidence of overconfident managers falling prey to

the winner's curse, while Boone and Mulherin (2008) find, to the contrary, that a competitive market

holds. New findings, provided by laboratory experiments on the winner's curse, can prove insightful.

Though the design of these tests can induce biases (Hansen & Lott, 1991) and they can neglect

institutional features which aim to mitigate the winner's curse (Dyer & Kagel, 1996). The chief

concern, as indicated by Thiel (1988), in respect to empirical field studies of a winner's curse, is the

difficulty in accurately inferring a benchmark value of reference for the auctioned item.

The sole extant study of a winner's curse in a real estate setting, Tse, Pretorius, and Chau (2011),

reports bid shading, in respect to auctioned asset price uncertainty. It is posited that this bid shading, by

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The firm acquisition process can be viewed as similar to an English open out-cry auction (e.g., Fishman, 1988; Ravid &

Spiegel, 1999).

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