What Is The Property Common Value In An Auction?
In an auction, the “common value” refers to the intrinsic value of the item being sold that is common across all bidders, even if their personal estimated valuations differ initially. This is in contrast to a “private value” auction where each bidder knows exactly their valuation. With common value auctions for assets like property or art, there is uncertainty about the underlying precise value, so bidders utilise the information from others’ bids to update their value estimates.
For example, say a house is being auctioned and Bidder A estimates it is worth £200,000 based on their research and preferences. However, Bidder B bids up to £250,000 before dropping out. This reveals that Bidder B likely valued the property higher after inspecting the interior condition, making improvements, researching resale potential etc. So Bidder A updates their initial loose valuation – the “common value” is higher than they first thought. This concept keeps the bidding increasing, sometimes well beyond what some bidders originally budgeted in their independent valuations.
The Concept Of Common Value In Auctions
In essence, the intrinsic “common value” remains fixed for that asset, but it is difficult to pinpoint at the outset due to information asymmetry among bidders. The bidding itself serves to aggregate and piece together various information sources to reach a sale price. The winner likely has the most complete information, aligning closely with the unknown actual common value. Auctions thus aim to maximise price discovery of the underlying common value.
Sources Of Uncertainty In Property Auctions
Several factors make it challenging for bidders to independently appraise a common accurate value for a property at auction:
Bidders may only get a quick walkthrough or external viewing. Defects like dampness or structural issues may go unnoticed initially. Photos may also inadequately convey size, condition and aesthetics. A winning bidder later spending weeks in the house is likely to discover much more about its intrinsic qualities. Their winning bid likely better reflected the ultimate value after repair costs, utility costs, décor etc.
Unknown Improvements/Development Potential
Owners and builders may recognise the financial potential to add extensions, convert attics/garages etc. that is not obvious to external bidders in a listing. Improvements can greatly impact property valuations once understood. Those able to accurately value enhancement possibilities may prevail at higher bids.
Recent comparable sales may reveal emerging trends in pricing in that area that catalogue listings do not emphasise. For example, new transport links planned nearby or changing school catchment zones can impact values. Some professional investors may have inside track knowledge allowing them to more accurately estimate true worth.
Neighbourhoods can rapidly gain or decline in popularity and prestige over a short time. Buyers personally visiting may better judge area vibrancy, hospitality and safety compared to basic listings. They may also visualise a home’s flexibility to adapt to future family needs better than catalogue descriptions allow. These insights can raise bidders’ common value estimation beyond initial assumptions.
Subjectivity of Desirability
Home features like gardens, natural light, storage etc. have subjective desirability influencing common value assessments. Buyers inspecting in person likely determine inherent quality and appeal more accurately than remote bidders relying only on listings. The winner’s common value estimate is likely the most accurate once incorporates subjective preferences.
Common value uncertainty stems from the limited time and means bidders have to fully assess properties remotely. Onsite inspections, market research and projected transformations require greater effort and expertise to accurately estimate end valuation – the common value estimate gets updated iteratively through the bidding itself. Auction winners willing to bid the highest often have some information advantage and/or greater means to enhance desirable features recognised after purchase.
Winner’s Curse Phenomenon
The inherent risk auction bidders face from the “winner’s curse” further complicates deriving accurate common value estimates independently. This economic principle states that the winning bidder is often the most inaccurate in judging value, carried away in auction fever to overpay relative to actual worth. They fail to incorporate signals from other bidders dropping out that inferred more rational valuation ceilings. Various studies show auction winners frequently regret overbidding soon after sales conclude (a.k.a “buyer’s remorse”).
The winner’s curse intensifies when the asset has an unclear common value with greater uncertainty. Bounded rationality comes into play – bidders get anchored on their initial private value estimates even as new price signals suggest the common value differs significantly. They may linearly increase bids by minimum increments until exceeding reasonable market prices aligned with actual worth upon more careful judgment later. Auction dynamics can create an adrenalin rush pressuring bidders anxious about losing out, overriding rational judgement.
For significant assets like property, the winner’s curse can leave successful buyers stuck overpaying on purchases way beyond budget. They may find themselves cash-poor for vital repairs or improvements needed post-purchase given initial funds allocated based on lower independent valuations. New unanticipated costs can leave the winning bidder financially burdened with insufficient contingency resources.
The winner’s curse highlights the need for auction participants to carefully factor risk premiums into their bidding thresholds, suppressing the innate desire to stay attached to initial value estimates without revising for new price signals. Valuation discipline must override auction atmosphere emotions and competitive instincts during intensifying bidding wars. Periodic timeouts evaluating signals from underbid dropouts can inject rationality against the pull of the winner’s curse risk.
Difficulty Adjusting For Winner’s Curse Mid-Auction
Ideally, bidders should incrementally decrease their common value estimates with every higher opposing bid made to account for the winner’s curse probability at those ascending price points. However, such adjustments prove quite difficult in the rapid-fire speed of bidding wars in live auctions. Reaching split-second bidding decisions allows little chance to consciously apply discounted valuations before paddle raises lock-in escalating commitments. The basic oxygen of any auction environment deprives the Carbon dioxide for clear-headed value analysis as auctioneers catalyse snap bidding reactions.
With property auctions also limiting thorough inspections, bidders have inadequate environmental information to accurately assess risk-adjusted value changes during the heat of auction events anyway. Rapid paddle raises combined with limited property insights make it near impossible for bidders to consciously factor in the winner’s curse probability right as opposing bids increase. Auction design intentionally pressures bidders psychologically to think less and bid more under urgent time constraints and public scrutiny. This gets bidders carried away faster into inflated purchase mistakes.
Post-auction regret and financial difficulties from overbidding are hardly surprising outcomes given the inability to consciously mitigate the risks from potential winners’ curses at the fast pace of auction events. In contrast, private sales allow days or weeks of careful reflection on value at each higher offer stage without manipulated time pressures. More stable mindsets lead to more rational common value estimations resistant to the winner’s curse problem that auctions structurally amplify to maximise sale prices (and commissions).
Unreliable Proxy Bidding Mitigation Method
A proxy bidding system utilised in some property auctions aims to help bidders avoid overpaying in the heat of auction fever by allowing pre-submitted maximum bids. Proxy bids increase automatically on attendees’ behalf by preset increments as prices rise, removing atmosphere influences. However, proxies can prove unreliable at truly capturing rational common values resistant to winner’s curse risks. Proxy levels get set initially during inspection periods well ahead of the actual bidding war auction environments.
But as covered earlier, limited inspections provide inadequate grounds for accurately setting absolute maximum valuations or appropriate risk premiums. Also, the emotional experiences of auction events still impact proxies; attendees usually raise caps as competitive juices and peer pressures flow freely in auction halls. Few bidders wanting to avoid losers’ regret stick rigidly to original proxies if initially losing out. The dynamics still exacerbate bounded rationality and escalating commitments that impair common value integrity. So proxies largely just delay rather than prevent the winner’s curse risks from corroding rational assessments.
Auction bidders cannot independently assess precise intrinsic property values ahead of time due to:
- Limited inspection opportunities
- Asymmetric insights on enhancement possibilities
- Inability to fully research market trends and area transformations
- Failure to accurately predict future neighbourhood desirability
- Subjective determinations of quality and desirability
Uncertainty around common values stems from a lack of effort/expertise in checking the above factors. The auction winner likely has superior insights into the property’s worth. Their winning bid thereby reveals a superior estimate of the property’s underlying common value.
Winner’s curse phenomenon further clouds independent common value analysis. The winning bidder tends to get over-carried away beyond rational value thresholds in the competitive rush of auctions. They often later regret overpaying relative to actual worth. The rapid pace of bidding wars allows little chance for bidders to consciously downward adjust common value estimates to mitigate winner’s curse risks at each higher price level during live auctions. Limited inspections also constrain risk-adjusted analyses.
Proxy bidding systems provide unreliable protection from overpaying. Proxies get set based on similar limitations as independent valuations ahead of auctions. Auction environment pressures still tend to erode rational assessments during events.