Who wins online auctions: The smart gambler or the lucky one? New research shows that it’s the lucky one who uses a winning strategy.
But researchers at Northwestern University also found that all players in an online auction intuitively use the right strategy, which turns the auction into a game of pure chance.
The findings, published by the journal PLoS One, provide insight into gambling in other areas, such as playing the stock market or real estate market.
“There are many contexts in which we think we are smart and at an advantage, such as buying real estate as prices start moving up,” said Luís Amaral, a professor of chemical and biological engineering in the McCormick School of Engineering and Applied Science.
“But we don’t realize we are competing against people doing the same thing. The advantage is gone, and it becomes a game of chance — so you better enjoy the process.”
Amaral and his colleagues studied public data on 600 online auctions in Australia and Europe, played by 10,000 different auction participants with a total of 200,000 individual bids.
Amaral notes the work of Nobel Laureate John Nash on game theory is very relevant to these auctions, as an online auction is a classic game — you have some information and you try to guess what other people are doing, and, based on that guess, you try to define your best strategy.
In what is known as a lowest unique bid auction, participants place bids for a relatively valuable item, such as a car or boat, in an attempt to have the lowest unmatched bid at the time the auction ends. The lowest bid is one cent, and the participant pays a fee, often a dollar, for each bid.
After placing a bid, the participant is told if his or her bid is winning. If not, many bid again — some up to hundreds of times, paying each time to make a bid. This means that, on average, an auctioneer earns double the cost of the item being auctioned while participants can pay hundreds of dollars to lose.
The researchers conducted a computer simulation to identify the optimal strategy in lowest unique bid auctions. They found the strategy is a “bursty” one: Consecutive bid values initially are close to each other, and then there is a long jump, where more bid values are placed close to each other. The pattern is often repeated several times.
For example, say an auction participant places a bid of 8 cents. Then he places a number of nearby bids, 5, 6 and 7 cents, as well as 9, 10 and 11 cents. Then he makes a large leap to a different area, placing a bid of 47 cents and also placing several bids around that number. Every time he places a bid, he pays a fee.
This mixed strategy combines exploitation (taking small steps in one area) and exploration (taking a big step to a new area). It is a smart strategy that gives you a better chance of winning, but the researchers discovered all the other participants have figured it out, too, wiping out any advantage to individuals.
“We couldn’t identify a single person who was not using this strategy,” Amaral said.
The optimal strategy is similar to what an animal foraging for scarce food employs, he notes. An albatross, for example, has a vast ocean to explore, so it focuses its fishing in a small area for a time and then moves a great distance to try another area. Then it repeats this pattern.
In lowest unique bid auctions, people want to win and become overly optimistic about the amount of money they will lose. They enter the auction to try to win a valuable item for a low price, but then they go on to irrationally stay in the auction — which is just a game of chance — and bid too much.
“At some point people will stop playing these online auctions,” Amaral said. “Humans are smart about recognizing the deck is stacked against them.”
Source: Northwestern University