Winner’s Curse

Neuroeconomist Samuel McClure on the ultimatum game, overbidding, and the neural basis of competitiveness

videos | October 1, 2015

What is the relationship between the amount of resources you possess and well-being? Why did the oil companies who won the competition for the right to drill pay more than the oil was worth? Which hormones influence the susceptibility to the winner’s curse? These and other questions are answered by Assistant Professor of Psychology at Stanford University Samuel McClure.

A fundamental question in Economics, in Psychology, is what are our goals, how do we behave, what is it out in the world that attracts us and makes us seek something out? Some of the things we seek out are pretty easy to intuit. You know, like food, water, opposite sex, but some are sort of more abstract. One big area that people have been interested in is social. How is it that we interact with other people? We are very social species. You know, what is it about the social world that drives our behavior? And there has been a lot of interest in things like altruism. So it turns out that even when people are given the chance to be very unfair to other people they are not. So there is a classic game called “The Ultimatum Game” where you can propose a split of a certain amount of money and a poor sucker who has to decide whether this is a fair split or not, declines that they don’t get any money in the end. So you put them in this very unfair position and people are very fair, they make very even splits, much more even than you should rationally predict. And the explanation for this is that we have this preference for fairness and that gives rise to things like altruism.

You know, exactly, all the different components of the social world and social motivations that interact, guide our behavior with other people are really hard to track down but there is at least one other that is really fundamental. It is competition. So not only do we tend to be fair but in other circumstances we tend to really like to dominate people. And one thing that has been well known and well appreciated is that with humans and other animals – your happiness and your well-being doesn’t just depend on how much money or resources you personally have. It has to do much more with how much resources you have relative to other people which is a strange and very troubling fact but it’s just a fact. So the wealthy people in very poor countries do much better than the poor people in relatively wealthy countries even though they may have fewer resources and fewer access to health care and worse food and so on. They are just healthier people, they live longer, they are happier and it’s just a big problem. And the hypothesis explains that you drive happiness not just from how you are doing but how you are doing relative to others. So this is probably another really fundamental human motivation and it shows up a lot in the world, in a real world. So one area where this really shows up is this phenomenon known as the Winner’s curse.
The Winner’s curse has a beautiful name and to describe it is to back up a little bit. The winner’s curse shows up in auctions. So auction is where there is a limited amount of resources and multiple people competing for access to these resources. The winner’s curse shows up in auctions in which the resource under consideration has some fixed value like a real true value. It is just that people are uncertain about how good it is. The most famous case of the winner’s curse showed up in drilling rights for oil. So in America in the Gulf of Mexico the government would auction off platted land you can drill for oil and then different oil companies would bid for the right to drill there. And then whoever paid the most money, who got the right to drill and would reap the benefits.

But it turned out that they didn’t really reap the benefits. Because of the competition the people, the companies that won the auctions tended to pay more than the actual oil was worth. And it was the sort of a big mystery for why this is the case, why is it that these companies were paying more than the actual value of the oil. And this is where the name the winner’s curse comes from. Because the companies that won later on would curse themselves for having paid too much.

And there’s been, you know, work recently arguing that this depends on competition. So you can do the same kind of experiments in a laboratory. You bring a bunch of people in, you have them compete for a limited resource and make bids for how much they wish to pay for it. And then you pay them for an experiment based on how much they pay for the good under auction relative to its true value.

Even in these scenarios you find that people, they can learn, they can better at the task. First they start to lose a lot of money as people are overly aggressive in their bidding but then they get better, better and better. And as they get better, better and better they lose less money but they never stop losing money. And some of the famous experiments in Economics showed that people, even if you have subjects come back, become professional subjects, essentially, come back over months and months and months. They never stop losing money. So this winner’s curse is this persistent effect. They do this even though there are real consequences. So one of my favorite studies ever had people come in and do this auction experiment. And if they lost money, so they ended up in the red, they ended up losing money over all, they made them work to pay it back. So they had to sweep the floor at the Economics building to pay back the money they had lost in the experiment. And they still continue to lose money. They couldn’t help themselves.

So some of the studies we’ve been doing’s been trying to figure out what’s going on in these tasks. And really our answer is that we think that there are two fundamental components to this. One is this how in the world that people learn how to bid in this task at all – the sort of first part that we’ve been trying to answer – one of the processes. The one standard explanation is, you know, you reason through, you have some estimate by how valueable the thing is and you reason through how you should bid relative to that estimate to guarantee they make some profits.

We don’t think that’s really what happens. We think what happens is people receive an estimate, they try it out, if they lose money then they bid a little bit less the next time. And then, they adjust their bid in this way. And we have good evidence this is actually the case: you can track behavior trial by trial in this experiment, you can predict how they bid just by assuming that they try something out in and then adjust based on wins or losses. But even if you just adjust in this way you should still eventually arrive at the optimal solution and make money on the task.

Psychologist Samuel McClure on neurotransmitters, errors in prediction, and neuromarketing
So what we’ve shown now is that it’s not just, you know, learning from wins and losses. It’s also something about the competition. So if you change the social environment in some way, the effect, the size of the winner’s curse changes as well. So we put people in a highly competitive situation. So I’m at Stanford University, a professor at Stanford. Our archrival is the University of California, Berkeley. So we’ve brought people into the lab and made them believe they are bidding against other students at Berkeley. And they lost much more money than if they thought they were bidding against Stanford students. So there is evidence there is something about the social environment. If you make them believe they are bidding against computer opponents then they don’t over bid at all. So there is really something about this social atmosphere. We think it’s something directly about competition.

There is something about wanting to win the auction, to be the winner, to be the one who emerged out of the group of competitors with the good in hand that drives people to overbid. and it’s very much related, you know, to this basic social drive to dominate. There are some hormones associated with this drive as well. So the most famous is testosterone. So testosterone levels rise as testosterone is associated with increased drive for social standards, intention to social status. And we’ve shown that overbidding in the winner’s curse scales the amount of testosterone in individual people. So we did this just in men. But in men if you measure the amount of testosterone in their system then people with higher levels of testosterone tend to bid more and they lose more money on the task than people with lower levels of testosterone.

And we’ve also tracked it down into the brain. So we’ve taken these two sets of processes. One is the trial by trial learning. And we’ve shown that we can identify brain system, particularly this dopamine system located in the midbrain. We’ve shown that we can track activity in the dopamine system and show that it changes trial by trial in a manner that predicts this sort of eventual convergence in the learning in that course. But there are other systems that are associated with social cognition. So there is a brain region that is called the temporoparietal junction which is really critical for thinking about other people, reasoning in the social environments. And other called the anterior insula which interacts with the temporoparietal cortex – to navigate the social environments, social networks, I guess. These two systems interact and we show that when you win or lose in auction, that these brain areas are active and the degree to which they’re active, predicts the degree to which you overbid.

So there is something about evaluating the social environment trying to establish yourself as dominant within there that leads to activity in this social cognition-related areas the brain that interact with basic evaluation system to lead people to overbid. I think this type of study – trying to pull apart different social motives, identify the brain circuits associated with them to identify exactly how it is that we evaluate our social world and change our behavior, change the way we evaluate things on the bases of these evaluations – this is really fundamental to understanding how we interact as a social species and why the different motives are the driver of behavior when we interact with others.

Assistant Professor of Psychology, Stanford University
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