The Winner's Curse: Why Being the Winner Can Be Bad

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• Sometimes “winning” can be a red flag, because the person who wins may simply be the one who overpaid or overestimated the value.
• Because of this, it’s easy to double down and get pulled along by the crowd.
• This piece explains the "winner’s curse" and shows a few simple ways to spot it early and avoid paying the price later.

Markets are often described as efficient, rational, and self-correcting. Prices move, capital flows, and errors are supposed to disappear the moment someone smart enough notices them. That story is elegant, but it’s also incomplete.

If markets were perfectly rational, mistakes would be random. They would cancel out. But many of the most persistent market errors are not random at all. They show up again and again in auctions, housing, IPOs, stimulus programs, and even in how people think about grocery money versus retirement savings.

Behavioral economics exists to explain these patterns, not by accusing people of being foolish, but by showing how real humans simplify difficult choices. One of the most powerful ideas in that tradition is explored in The Winner’s Curse, a book that examines how intelligent people systematically overpay, misprice, and misunderstand risk, even when incentives are clear.

The book poses a deceptively simple question: why don't people make “perfectly logical” choices with money and everyday decisions?

Why Winning Can Be a Losing Proposition

The winner’s curse describes a paradox that shows up most clearly in auctions. Imagine a group of bidders estimating the value of an asset whose true worth is uncertain but shared by everyone. An oil field, a jar of coins, or a company going public all fit this description.

The key insight is subtle. The winner of the auction is not a random participant. They are the ones who most overestimated the value. When many people guess, the highest guess tends to be wrong in a specific direction. Winning, in this context, is evidence of error.

This occurrence is not a theoretical curiosity. The phenomenon was first documented by oil executives who noticed a strange pattern: Whenever their firm won drilling rights, the actual oil discovered was less than expected. They were not unlucky. They were victims of selection bias.

Markets reward optimism in competitive settings, but the problem is that optimism compounds when everyone is estimating the same uncertain reality. The more competitors involved, the more confident you should be that winning means you paid too much.

This helps explain why aggressive bidding wars often end badly, why acquisitions frequently disappoint, and why IPOs tend to surge and then underperform.

The Law of One Price and Its Violations

Traditional finance relies on an assumption called the law of one price: Identical assets should trade at identical prices. If they do not, traders should step in, exploit the difference, and restore order. In reality, traders often violate this law more frequently than theory would predict.

One famous example involved a large industrial firm that spun off a technology subsidiary. Shares in the subsidiary traded at a price that implied the parent company had negative value. This was not a matter of opinion or hidden risk. It was simple arithmetic, and yet the mispricing persisted.

These episodes matter because they remove easy explanations. When arbitrage is straightforward and barriers are minimal, price discrepancies should vanish quickly. When they do not, the problem is belief.

Investors may buy not because they think something is worth its price, but because they think someone else will pay more later. Markets can be driven by second-order thinking about other people’s mistakes. Ironically, that belief can lead to mistakes.

Mental Accounting and the Stories We Tell About Money

One of the most practical ideas in behavioral economics is mental accounting. In theory, a dollar is a dollar. In reality, its meaning depends on where it came from and what story we attach to it.

People treat salary income differently from bonuses. They treat stock gains differently from home equity. They treat gift money differently from tax refunds. None of this makes sense in a spreadsheet, but all of it can make sense in a human brain.

Mental accounts are shortcuts. They reduce complexity by separating money into buckets: grocery money, vacation money, retirement money, found money. These shortcuts help people function. They also shape behavior in predictable ways.

Home equity, for example, has a remarkably low propensity to be spent. Even when homeowners sell and move, many mentally roll that equity into the next house rather than treating it as spendable wealth. The account persists even when the asset changes.

This helps explain why wealthier households don’t necessarily save more from income than others. Their wealth sits in accounts that feel untouchable: stocks, retirement plans, and property. The discipline comes from structure, not virtue.

Why Stimulus Often Misses Its Target

Mental accounting has important implications beyond personal finance: It shapes public policy outcomes in ways that are rarely acknowledged.

When governments want to stimulate spending, they might distribute money through mechanisms that resemble regular income. Payroll supplements, tax withholding changes, direct deposits that look like paychecks.

From an economic perspective, this should work. From a behavioral perspective, it often does not. Money that feels like income tends to be saved or absorbed into existing budgets, and money that feels like a bonus is more likely to be spent. The label matters as much as the amount.

This helps explain why some stimulus programs fail to generate the expected economic activity. The problem is not stinginess. It’s categorization. People put the money in the wrong mental account. Good policy design requires understanding not just incentives, but perception. How people interpret a payment determines what they do with it.

Complexity Is the Real Enemy

Many behavioral anomalies share a common root: complexity. When choices are simple, people usually get them right. When choices are high-dimensional, abstract, or unfamiliar, intuition takes shortcuts.

This is why people fail simple logic puzzles even when the math is trivial. This is why many delay enrolling in retirement plans despite generous employer matches. It’s also why investors chase past performance even when they know better.

The problem is rarely a lack of intelligence. It’s a lack of focus.

One of the more striking findings in behavioral research is that people tend to know how to solve a problem. They just do not slow down enough to do it. Writing things down, breaking decisions into steps, and reducing dimensionality dramatically improves outcomes.

The lesson is not that humans are hopelessly irrational. It’s that attention is scarce, decisions compete for it, and the harder the choice, the more likely intuition fills the gap.

Why Markets Do Not Self-Correct as Quickly as We Expect

If mistakes are obvious, why do they persist?

The standard answer: limits to arbitrage. Exploiting mispricing often requires leverage, patience, and tolerance for volatility. Even correct trades can fail before they succeed. As the saying goes, markets can stay irrational longer than you can stay solvent.

There is another layer, though. Many anomalies persist because participants believe others are making mistakes. Everyone thinks they are playing one step ahead. In reality, they are often reinforcing the same error. This creates a fragile equilibrium. Prices drift away from fundamentals not because people are clueless, but because they are second-guessing one another. These dynamics are especially dangerous during periods of optimism, when winning feels like validation rather than a warning.

How Can Investors Apply This?

The winner’s curse is not just about auctions. It’s a mindset risk. Anytime you win in a competitive environment, you should ask why. Anytime you feel confident because many others disagree, you should pause. Confidence is not proof. It’s sometimes evidence of selection bias.

For investors, this argues for humility. It favors process over prediction. It rewards skepticism of crowded trades and caution around narratives that justify paying more simply because others are willing to do so.

It also highlights the importance of structure. Automatic savings plans work not because people suddenly become disciplined, but because the decision is removed. Defaults matter and friction matters. So does attention.

Many of the most effective strategies succeed by making good behavior easier and bad behavior harder.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up for our Newsletter or subscribe on your preferred podcast platform so that you don't miss out on future episodes.