Auctions and Bidding Auction Theory Auction theory is

Auctions and Bidding

Auction Theory Auction theory is important for • practical reason • empirical reason – testing-ground for economic theory, especially of game theory with incomplete information • theoretical reason 2

Theoretical Reason • Help us understand other methods of price formation (posted prices and negotiation) • Close connections between auctions and competitive markets • Close analogy between theory of optimal auctions and theory of monopoly pricing 3

Types of Auctions • English auction – ascending-price, open-outcry • Dutch auction – descending-price, open-outcry • 1 st price sealed bid auction – known as discriminatory auction when multiple items are being auctioned • 2 nd price sealed bid (Vickrey auction) – known as uniform-price auction. . . 4

Confusing. . . In the financial community, • 1 st price sealed bid auction is termed an English auction (except by English, who call it an American auction); • 2 nd price sealed bid auction is called a Dutch auction. 5

1 st Price Sealed Bid Auction (In the Financial Community) Price Auction size Awarded price quantity 6

2 nd Price Sealed Bid Auction (In the Financial Community) Price Auction size Awarded price quantity 7

What are they? • Yankee auction – multiple-items auction – winners are determined by some ranking – successful bidders pay what they bid • simultaneous ascending auction – began in the US in July 1994 – US spectrum auction #4 in Dec. 1994 8

General Remarks about Auction • Complex auction strategies – risk attitude, one or multiple items, private or common value, secret information, etc. • The only piece of information available to all is the rules of an auction. • Economists use the framework of game theory to study auction behavior. 9

Key Feature of Auctions The Presence of asymmetric information • private-value model • pure common-value model • general model – each bidder’s value is a general function of all the privately-received signals 10

Theoretical Predictions • English and 2 nd price sealed bid auctions are strategically equivalent, or isomorphic. • Dutch and 1 st price sealed bid auctions are also strategically equivalent, at least in theory. 11

Buyer’s Bidding Strategy (I) • English auction – bid a small amount more until reaching the valuation, then stop • 2 nd price sealed bid auction – the dominant strategy is to submit a bid equal to his valuation, namely truthtelling 12

Buyer’s Bidding Strategy (II) • Dutch auction – no “optimal” bidding strategies – decide in advance the maximum amount to bid • 1 st price sealed bid auction – no “optimal” bidding strategies – tradeoff is between winning more often and benefiting more 13

Dutch/FPSB Auctions Suppose only two bidders. Both bidders’ valuation of the good are taken independently from a uniform distribution over values between 0 and 1. Bidder 1’s expected return is E(R 1) = (V 1 -b 1) Prob(b 1 b 2) 14

Recall “After work…” Suppose you are one of the two bidders involved in the first price sealed-bid auction of a rare stamp. The stamp is worth $700 to you. Having sized up your opponent, you think it could be worth anything between $0 and $1000. 15

NE in Dutch/FPSB Auctions • bi = Vi/2 for the case of two bidders • bi = (n-1)Vi/n for the case of N bidders 16

Bidder’s Winning Strategy • Avoid pitfalls – winner’s curse • Always bid cautiously – Don’t let the presence of several competing bidders push you into making too aggressive a bid. 17

You cannot make money if you are too cautious? Milgrom (1989, JEP). . . returns in bidding come from cost and information advantages, . . . bidders without some advantage have little hope of earning much profit, but could with a little bit of carelessness suffer large losses. 18

Seller’s Expected Revenue (Risk Neutral Bidders) Common Values Independent Private Values < = English = 2 nd price Dutch = 1 st price English > 2 nd price 19

Seller’s Expected Revenue (Risk Averse Bidders) Common Values Independent Private Values ? < English = 2 nd price Dutch = 1 st price English > 2 nd price 20

Seller’s Auction Strategy Revealing information removes uncertainty – link the final price to outside indicators of value (an authoritative evaluation) 21

Auctions in E-Commerce Buyers One Many One Negotiations using EDI Web-based sales auctions Many Web-based Procurement auctions Web-based many-to-many auctions Sellers 22

Auctions in E-Commerce • Web-based sales auctions – Onsale • Web-based procurement auctions – GE TPN • Web-based many-to-many auctions – Arizona Stock Exchange 23

Auction in E-Marketplace • Seller controlled marketplace – vendor web sites with auction • Buyer controlled marketplace – web site procurement posting – purchasing agents – purchasing aggregators • Neutral marketplace 24

Role of Neutral Intermediary • Advantage of scale of transaction processing – may act as service bureaus – collect valuable selling/buying information • How to provide more value to sellers and buyers 25