Thursday, April 21, 2016

Choosing Auctions

The revenue equivalence theorem identifies conditions where the type of auction is irrelevant to seller revenues. But how should one choose between auction forms when these conditions do not hold?

Open versus Closed

An open auction, an English auction for example, has the property that bidders can adjust their bids to others in a dynamic fashion. In a closed auction, bids are sealed. An open auction is another way to achieve linkage. If bidders' values are correlated, as in the mineral rights model, then, on average, the seller earns more from an open than a closed auction. The reason is that others' bids reveal information, much like an appraisal. This more tightly correlates perceived values and intensifies competition, an effect absent in a closed auction.

So why are closed auctions run? There are several reasons.
1. Cheating: It is easier to engage in bid rigging in an open auction since the bids of others in the ring can be monitored, and countered, if someone decides to deviate.
2. Liquidity: An open auction requires people to participate at a specific time and place. This could reduce the number of bidders attracted to the auction, leaving the auctioneer worse off.

High Bid versus Second Price

A high bid auction is simpler for bidders to understand, even if the equilibrium bidding strategy turns out to be more complex. It is also less subject to the problem of shill bidding, bids made by the auctioneer to boost the price of the item. Second-price auctions invite shill bidding, especially when it is hard to verify who placed what bids.

On the other hand, bidding in the second price auction is simpler, once it is explained. It is more robust to errors on the part of other bidders. Finally, optimal bidding in the first price auction requires knowledge of the number of competing bidders. In the second-price, it does not. For inexperienced bidders, the lack of knowledge about the level of competition, and hence the right amount of bid shading to engage in, represents a serious entry barrier.

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