An Iterated Prospect Theory Model for the Dutch Auction

Dutch auctions are used in many industries. Goods are initially offered at a high price, which is gradually lowered until the first bidder accepts it. Bidders trade certainty and price: early bids secure the sale, but overpay; later bids are cheaper, but risk losing out to another bidder. We used group-based laboratory experiments to investigate decision-making in Dutch auctions. We developed a model for bidding in Dutch auctions, based on a dynamic extension of Prospect Theory. At each moment of the auction, the buyer is faced with a decision that can be framed as classical Prospect Theory: a certain option (buy now!) or a risky option (wait a little longer for the price to fall, and hope that no-one else buys before then). We show that this model reproduces the basic phenomena of the task, and also provides a useful framework for investigating interesting questions about auction psychology. We also discuss extensions to data from real Dutch auctions.