Why People Fail to See their Dominant Strategy in Strategy-Proof Auctions

By Sebastian Schweighofer-Kodritsch and Yves Breitmoser

Decision-making in strategic interaction is typically challenging because figuring out one’s best course of action requires figuring out what others will do. Allocation mechanisms are often designed to simplify the problem: by offering every participant a dominant strategy – one that is optimal regardless of what others end up doing – they remove any need for strategic reasoning. Mechanisms with this property are called strategy-proof.

People often fail to choose their dominant strategy, however. A leading example concerns the sealed-bid second-price auction (2P) and the ascending-clock auction (AC) with privately known values. In 2P, participants simultaneously submit their bids and the good is allocated to the highest bidder at a price equal to the second-highest bid. In AC, a price clock starts low and then gradually ascends; participants continuously decide whether to keep bidding or irreversibly drop out, and the good is allocated to the last active bidder at a price equal to the price at which the last competitor(s) dropped out. The two auction formats are theoretically equivalent, and both are strategy-proof: In 2P you bid your value, in AC you remain in until the clock price reaches your value. Yet, empirically, they differ: while people quickly figure out this dominant strategy in the dynamic AC, there is persistent overbidding in the static 2P.

What exactly drives this difference? An influential recent proposal by Shengwu Li suggests that it is due to people’s failure to contingently reason, which is necessary to recognize dominance in 2P but not in AC. He formalizes a theoretical strengthening of dominance/strategy-proofness that should make dominance obvious even to people that fail at contingent reasoning. This obviousness criterion selects dynamic mechanisms over static ones.

BCCP Fellow Sebastian Schweighofer-Kodritsch and co-author Yves Breitmoser provide the first systematic experimental investigation of how each of the elementary design differences between 2P and AC affect behavior. The authors add intermediate auction formats to quantify the cumulative effects of (1) simply seeing an ascending-price clock (after bid submission), (2) bidding dynamically on the clock, and (3) getting (theoretically irrelevant) drop-out information about other bidders. Li’s theory predicts dominance to become obvious through (2), dynamic bidding. The authors find no significant behavioral effect of (2), however, while the feedback effects (1) and (3) are highly significant. The results thereby help to uncover additional aspects of what is cognitively hard.

A further analysis (relying on a structural model) suggests that people quickly understand that underbidding is dominated but fail to do so for overbidding; mere clock presentation, independent of how actual bidding is done, prevents overbidding by leading bidders to cognitively evaluate their bid incentives in an incremental fashion, starting from low bids and moving up towards their value, which produces a countervailing underbidding tendency.

The authors conclude that people do not look for dominance and therefore do not just see it, irrespective of whether it is theoretically obvious or not, but rather have to discover it via learning from feedback. This learning process is influenced not only by the informational content of feedback, but to a large extent also by how that very content is presented.

The full paper "Obviousness around the clock" is published in Experimental Economics.

This text is jointly published by BCCP News and BSE Insights.