Ever wondered what causes the spate of wild bidding in the last few minutes of an Ebay auction? Scientists say they now have answer: The irrational behavior is caused by people’s fear of losing, not their desire to win. While economists have recognized the concept of “loss aversion” for some time, a new set of experiments used brain scans and lab experiments to show how strongly the phenomenon plays out in auctions, and how it’s tied to overbidding.
In the first experiment, test subjects participated in either a lottery or an auction. During the games, scientists watched the responses of the subjects’ striata—the brain’s reward center—using functional magnetic resonance imaging (fMRI). The elation of winning was the same in both games, but the agony of defeat was crushing for losers of the auction. After auction, brain activity in the loser’s reward centers decreased substantially. But it hardly blipped when the person lost a lottery [Ars Technica]. What’s more, auction losers who had the steepest declines in striata activity were more likely to have overbid during the auction.
Intrigued, the researchers decided to test the hypothesis that fear of losing was overbidding’s main cause with another experiment, in which all the test subjects participated in auctions. They told half the subjects that they would start the auction with a $15 bonus, which they got to keep if they won. The other subjects were told that, when the auction was done, if they won they’d get an extra 15 bucks. Either way, the winners would get the same bonus. But the researchers found that people bid more when they were afraid they might lose the money they already had [Scientific American].
Experts say the study, published in Science [subscription required], could point the way towards future experiments to understand the root causes of irrational behavior and poor decisions. Professor Nigel Nicholson, an expert in organisational behaviour at London Business School, said the results made a lot of sense as “loss aversion” is known to be a strong driver of human behaviour. “People hate to lose much more than they like to win.” He added that these types of imaging studies were helping to boost understanding of decision-making, for example in the stock market [BBC News].
Economists are still working on ways to mathematically model this kind of behavior; read about it in the DISCOVER article “The Mathematics of Auctions.”