Overconfidence in the art market: a bargaining pricing model with asymmetric disinformation

Economia Politica https://doi.org/10.1007/s40888-022-00273-9 ORIGINAL PAPER Overconfidence in the art market: a bargaining pricing model with asymmetric disinformation Francesco Angelini1 · Massimiliano Castellani1 · Lorenzo Zirulia2 Received: 7 October 2021 / Accepted: 20 May 2022 © The Author(s) 2022 Abstract This paper develops a Nash bargaining model of price formation in the art market. Agents can be naïve, if they are overconfident and either overestimate artistic quality or underestimate their uncertainty of artistic quality, or sophisticated, if they correctly use all the available information. Overconfidence turns out to have a positive impact on both the price and the average quality of the artworks traded in the market. The impact of overconfidence on expected quality is weaker than the corresponding price increase, so sellers overcharge buyers. In addition, the buyer’s (seller’s) overconfidence has a positive (negative) impact on the likelihood of trade. If many pairs of agents may bargain simultaneously, we find that seller’s market power is negatively affected by the number of sellers and positively affected by the number of buyers. If sophisticated and naïve buyers coexist, naïve buyers exert a negative externality on the sophisticated ones, increasing the price the latter pay. Keywords Art market · Pricing · Overconfidence · Bargaining · Information · Belief · Art trade JEL Classification C78 · D4 · D8 · D82 · Z11 * Lorenzo Zirulia Francesco Angelini Massimiliano Castellani 1 Department of Statistical Sciences “Paolo Fortunati”, University of Bologna, Piazza Teatini, 10, Rimini 47921, Italy 2 Department of Economics, Management and Quantitative Methods, University of Milan, Via Conservatorio, 7, Milan 20122, Italy 13 Vol.:(0123456789) Economia Politica 1 Introduction Bargaining is a widespread practice in many areas of economic life within the market and non-market relations. In market relations, parties are often characterized by imperfect information on important elements of the transaction, such as the quality of the traded good, on which consequently they hold beliefs. As shown in the last decades by cognitive psychology and behavioral economics, beliefs are often distorted, and as source of belief distortion, a bias with important economic implications is overconfidence (Moore & Healy, 2008; Malmendier & Taylor, 2015). Overconfidence can take two main forms (Grubb, 2015): overoptimism and overprecision. Overoptimistic individuals overestimate their prospects or their abilities, while overprecise individuals underestimate uncertainty, thus placing overly narrow confidence intervals around forecasts. These biases can cause upward-biased estimates of the quality of a good (or downward-biased estimates of prices) thus leading to imperfect choices (Camerer & Lovallo, 1999; DellaVigna & Malmendier, 2006; Iossa & Palumbo, 2010; Grubb & Osborne, 2015). A market where bargaining, imperfect information, and overconfidence are jointly important aspects is the art market. As a matter of fact, “haggling for art” is a common practice, where sellers and buyers often engage in a bargaining process to establish the artwork’s prices, regardless of the selling method (posted or auction price) used by the art dealers (Velthuis, 2011). Dealing with goods that embody both cultural and economic values, agents in the art market usually operate in a context of “asymmetric disinformation” (Candela et al., 2012). Agents can be characterized by incomplete sets of information about artworks quality, and, to a large extent, heterogeneity arises because traders differ in their knowledge of how the art market works. On one hand, galleries, experienced collectors and artists are typically sophisticated traders, who have the expertise to correctly elaborate all the available signs and signals about the artwork and the artist, relying on a highly specific type of cultural knowledge or educational capital. On the other hand, less experienced collectors, who are particularly sensitive to trendy brands, may behave naively, suffering from “investment mania”, or be driven by “art passion” and not by the principle of risk minimization (De Vecchi, 2008; Candela et al., 2013; Kräussl et al., 2016).1 This paper aims to develop a model of the art trade in which bargaining is the selling method, and the bilateral relationships between sellers and buyers depend on their possibly divergent and biased beliefs on the quality of the artworks, considered as goods with exogenous quality (Candela & Cellini, 1998). In our model, artwork quality is a stochastic variable whose distribution is exogenously given, in that it is not influenced by sellers’ or buyers’ choices. Artwork quality is affected by an artist’s talent and fame, and agents in the art market can use signs and signals to proxy them. However, not all have the same ability to interpret these signs 1 Candela & Castellani (2000) noted that many economists such as Baumol claimed to be passionate connoisseurs but not experienced collectors. Concerning risk, inexperienced collectors are more prone to speculation or gambling when the prices of the artworks are volatile and the artists are not famous so it is difficult to predict the value of their artworks over time. 13 Economia Politica and signals (Candela et al., 2012). In particular, we assume that two types of agents exist: sophisticated and naïve agents. The former can interpret signs and signals properly, and hence they know the actual distribution of quality, that hereafter we will call objective distribution. Their reservation price, hence, hinges upon such a distribution. Naïve agents, instead, form their reservation price based on a subjective distribution of quality, which, due to overconfidence, has a higher mean and/or lower variance than the objective one. It follows that overconfidence does not affect quality, but only the perception of the stochastic process behind it. Our results can be summarized as follows. In the first part of the paper, we consider the interaction within a single buyer-seller pair, which models a situation in which the two agents do not consider the possibility to negotiate with other parties in case of disagreement. For the seller, the reservation price, i.e. the minimum price that she is willing to accept to sell the artwork, is determined by valuing the quality of the artwork based on a probability distribution, which is the objective one for sophisticated agents. The same is for the buyer’s reservation price, i.e. the maximum price that she is willing to pay for the artwork. By using a biased distribution, overconfident agents overestimate expected quality (in the case of overoptimism) or underestimate risk (in case of overprecision). In both cases, and irrespective of the side of the market that is biased (sellers or buyers), overconfidence has a positive impact on agents’ reservation prices. In turn, seller’s and buyer’s reservat (...truncated)