Thursday, April 18, 2013

Bidding bias

A recent article in the Journal of Consumer Research shows that when the bidders are unaware of the characteristics of their competition, they are likely to bid more aggressively – possibly indicating inefficient price outcomes. Although the study was done on bidding in the social channels over tangible products, the finding has implications for the financial markets as well.

By definition, the originator of a bid price on a financial asset in a liquid market does not know the characteristics of the counter-party. Does this mean that there is a built-in positive upward bias (aggressive bidding) in the prices of financial assets? The article does not seem to explain if there is an asymmetry – i.e. are the sellers of assets, equally aggressive, when they are lacking such information? And without that, it is difficult to conclude anything.

However, the finding seems to imply that transaction prices are less efficient when the buyers are sellers are unaware of the counter-party characteristics. An exchange, thus, may induce a level of inefficiency into transactions. This is an interesting area of research and if straight bartering has a higher probability of establishing efficient prices, then, it may have some policy implications.