March Madness in the Classroom

Pre-Auction Class Discussion

To get the most benefit out of the exercise, an instructor may wish to discuss the following concepts with students before conducting the exercise.

The Winner’s Curse

The winner of an auction for a commodity with unknown value will most likely be the bidder who has the highest estimated value of the good. Typically, the winner overestimates the value and then overpays in the auction. Bidders need to significantly shade their bids to ensure that if they are the highest estimator of value, they do not overpay for a good. Before the March Madness in the Classroom Auctions, an instructor may consider discussing the winner’s curse using the popular “Jar of Pennies” auction. The instructor brings in a jar of pennies and asks students to estimate the number of pennies in the jar. The instructor then allows students to bid on the jar (using a sealed bid or an open outcry format). Invariably, the student who wins the auction has overestimated the number of pennies in the jar and spends more than the jar’s value. Although this instruction should help students bid with more savvy in the March Madness in the Classroom Auctions, the “Winner’s Curse” still tends to appear in these auctions as well.

Bidding Strategies

An instructor may wish to discuss bidding strategies in a first-price open outcry auction, a first-price sealed bid auction, and a second-price sealed bid (Vickrey) auction. Students should be familiar with how bidding strategies change when bidders’ valuations are common or private and known or unknown. In the March Madness in the Classroom Auctions bidders’ valuations are private and unknown. Bidders must consider shading their bids to avoid the winner’s curse and to generate a profit.

Risk Management

The bidders’ estimation of a team’s sponsorship value is based on private beliefs of the probabilities every team will win against every other team in the tournament. Assuming these probabilities are accurate, a team’s estimation of value is the average payout one may expect if the tournament is played an infinite number of times. Only a risk neutral bidder can examine this expected value and compare it with a guaranteed payout of the same value. An instructor may wish to discuss attitudes toward risk before the March Madness in the Classroom Auctions to ensure that bidders properly interpret the sponsorship expected values.

Portfolio Diversification

In the March Madness in the Classroom Auctions, individual students will purchase full sponsorship rights to teams in the tournament. Once the auctions are complete, students may sell these rights in full or partial shares at any time. Before the auction, students may consider working in a group. It is up to the instructor to encourage students to do this or to observe whether they do it on their own. One member of a group may purchase a team and then sell partial shares to the rest of the group after the auction. This practice may limit the group’s risk and it may keep bid prices lower as there is less competition for sponsorships.