The Sunk-Cost Fallacy in Penny Auctions Ned Augenblick July 2015 Abstract This paper theoretically and empirically analyzes behavior in penny auctions, a relatively new auction mechanism. As in the dollar auction or war-of-attrition, players in penny auctions commit higher non-refundable costs as the auction continues and only win if all other players stop bidding. I first show that, in any equilibria that does not end immediately, players bid probabilistically such that the expected profit from every bid is zero. Then, using two large datasets covering 166,000 auctions, I calculate that average profit margins actually exceed 50%. To explain this deviation, I incorporate a sunk cost fallacy into the theoretical model to generate a set of predictions about hazard rates and player behavior, which I confirm empirically. While players do (slowly) learn to correct this bias and there are few obvious barriers to competition, activity in the market is rising and concentration remains relatively high. Keywords: Internet Auctions, Market Design, Sunk Costs JEL Classification Numbers: D44, D03, D22 Address: Haas School of Business, 545 Student Services #1900, Berkeley, CA 94720-1900
[email protected]. This paper was previously circulated with the title "Consumer and Producer Be- havior in the Market for Penny Auctions: A Theoretical and Empirical Analysis". The author is grateful to Doug Bernheim, Jon Levin, and Muriel Niederle for advice and suggestions, and Oren Ahoobim, Aaron Bodoh-Creed, Tomas Buser, Jesse Cunha, Ernesto Dal Bo, Stefano DellaVigna, Jakub Kastl, Fuhito Ko- jima. Carlos Lever, David Levine, Scott Nicholson, Monika Piazzesi, Matthew Rabin, and Annika Todd for helpful comments.