Bidding Models: Effects of Bidders’ Risk Aversion

Abstract

A revised optimum bidding model is presented which corrects the omission, in previous models, of the way contractors behave when confronting risk. Specifically, the model proposes to use a nonlinear function of profit to reflect the bidders aversion to risk. The need to use such a utility function is demonstrated through the analysis of over 4,400 bids on 858 public projects in Massachusetts during the 1966/75 decade. This evidence indicates that contractors behave differently when dealing with small and large projects, and when operating in good years or bad. They appear most risk averse toward larger projects in lean years, and bid relatively lower. This consideration can be incorporated into the standard bidding models by the simple devise of measuring the utility function of a bidder for a particular project, and inserting it as the measure of value in the formulas that determine the optimum bid.

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