Economic Analysis for Business Decisions Auctions and Bidding

Overview: Auctions and Bidding • Introduction to Auctions – Open-outcry: ascending, descending – Sealed-bid: first-price, second-price • Private Value Auctions • Common Value Auctions – “Winner’s curse” • Auction design affects “gaming” options Examples of Auctions • Internet • EBay.com, Amazon.com, Liquidation.com • Government • Treasury Bills, mineral rights (e.g. oil fields), assets (e.g. privatization) • Electromagnetic spectrum • Stocks • IPO: Google • Repurchases • Procurement auctions/Subcontracting • Automobiles: Valeo (GM, Daimler-Chrysler, etc..), Visteon (Ford) 1 Ways to Categorize Auctions • Number of objects – We focus on single object auctions, but ideas apply to multi-unit auctions • Role of information / Type of valuation – Private value vs. Common value • Rules of auction – Ascending (Ebay or Sotheby’s), first-price (oil tracts), etc.. Auction Formats • Open outcry auction – Ascending Auctions (English) • Auctioneer announces ever increasing prices to solicit bids. Continues until only one person left in. – Descending Auctions (Dutch) • Auctioneer announces decreasing prices until someone puts up their hand. • Sealed bid auction • Everyone puts bids in envelopes and gives to seller at the same time. • First price, Second price 2 Private Value Auctions • Each bidder knows his/her own valuation. ⇒ My valuation does not depend on your information • When is an auction likely not to have purely private values? – Resale possible – Some bidders are “experts” Common Value Auctions • All bidders have the same valuation but they don’t know what it is. ⇒ My valuation now does depend on your information • Most real-world auctions have a mixture of private and common values. Private Value Common Value 3 Example: Art Auction • 3 individuals with private values of $60,000, $70,000 and $80,000 for a work of art • What will happen in the ascending auction? • What if we used a descending auction? Ascending vs. Descending Auctions • Do bidders bid their true valuation in ascending or descending auctions? • Ascending: Yes - bidding up to your true valuation is the dominant strategy • Descending: No - each bidder “shades down” his bid. – Risk averse bidders shade less 4 More Bidders Matters • What if there were more bidders, say with private values of $60,000, $61,000, … , $79,000, $80,000? • More revenue in both ascending and descending • Ascending: Second-highest value is now $79,000 • Descending: Less incentive to shade bid since it’s more likely someone else will jump in with more bidders 5 Open Outcry vs. Sealed Bids • Second-price auction is equivalent to ascending auction – Winner pays second-highest (sealed) bid, virtually same as with an ascending auction • First-price auction is equivalent to descending auction – Same considerations in formulating bids 6 Bidding for an Oil Block • Five People will bid, in one-time first-price auction. The top bid gets the block • The true value of the field = XTrue, but no bidder knows what XTrue is. It will be revealed (drilled) after the bidding. • Each bidder hires his/her own consultant to give an expert estimate of the value. How Good Are the Experts? • Oil experts can estimate reserves only with some error. • The distribution of these types of oil estimates tends to be the following: ⎧X True + 40 ⎪ True ⎪⎪ X + 20 Consultant' s Estimate = ⎨ X True ⎪ X True − 20 ⎪ ⎪⎩X True − 40 w. p. 1/ 5 w. p. w. p. w. p. w. p. 1/ 5 1/ 5 1/ 5 1/ 5 • Given your consultant’s estimate, how much will you bid? 7 Winner’s Curse • Winner’s Curse = Tendency to overbid due to the fact that bidder with highest estimate (or signal) will win – An issue in all common value auctions, worse with more bidders participating – To avoid the curse, simply assume your signal is the most overly optimistic when bidding • Winner’s Curse ≠ “Money Left on the Table” 8 Internet Auctions • Millions of auctions each day. • Ebay format (most popular site) – Ascending auction – Second price (pay slightly above) – Auction ends exactly at a prespecified time • Amazon format – Auction ends once no new bids have been made for 10 minutes (i.e. flexible end time) “Proxy Bidding” and “Sniping” • “Proxy bidding” = programming a proxy bidder to bid up to your maximum willingness to pay at the beginning of the auction • “Sniping” = bidding at the last moment • Do you think sniping is more prevalent on EBay or Amazon? Why? • What risks are there to submitting a proxy bid? 9 Cumulative dist’n of auctions’ last bids over time Bid Rigging • Bid Rigging can be a big problem! • PCS (Personal Communication System) auctions (April 1997) • Marsh & McLennan and commercial insurance 10 Take Away Points • Don’t forget the winner's curse • Auctions are a way to 'discover the right price'. • In second-price private-value auctions, you should bid your true valuation. • Auction design influences behavior and performance: – More bidders increases revenue. – Fixed ending times lead to sniping, which may reduce revenue. – First-price auctions may increase revenue when bidders are risk-averse. 11