All Equilibria of the Vickrey Auction

Paul Heidhues WZB (Social Science Research Center Berlin) Reichpietschufer 50 10785 Berlin, Germany heidhues@medea.wz-berlin.de

Andreas Blume Department of Economics University of Pittsburgh Pittsburgh, PA 15260 ablume@pitt.edu

First Draft: June 2001, This Version: August 2002

Abstract This paper characterizes the set of Nash equilibria in the second-price sealed-bid auction with independent private values and three or more bidders. In addition, we show that any eective reserve price implies uniqueness.

We are grateful to Georgios Katsenos, Joel Sobel, an anonymous referee, and the associate editor for comments. Blume thanks the WZB, where this paper was written, for its hospitality and the NSF (SBR-9808947) for nancial support. Heidhues thanks the German Science Foundation (DFG, Ro2080/1-2) for nancial support.

Introduction

This paper characterizes the set of Nash equilibria in the second-price sealed-bid auction with independent private values, three or more bidders, and identical full supports. There exists a continuum of equilibria, which have a simple structure: Above some critical value, all bidders bid their valuations; below, one bidder bids the critical value, and all others bid zero. If one introduces a strictly positive reserve price, equilibrium becomes unique. Vickrey [1961] introduced the second-price sealed-bid auction. With private values, there is a unique equilibrium in undominated strategies: Bidders bid their valuations. Milgrom [1981] notes the existence of other (asymmetric) equilibria. For two bidders, Plum [1992] describes yet more equilibria. Bikhchandani and Riley [1991] and [1993] give conditions for uniqueness of equilibrium within the class of increasing and continuous strategies for common and interdependent values respectively. Bikhchandani, Haile and Riley [2002] characterize symmetric separating equilibria in English auctions. Maskin and Riley [1996] prove uniqueness for rst-price auctions, provided bidders never bid above their reservation prices. Lizzeri and Persico [2000] prove uniqueness for a variety of two-bidder auctions. Unlike Lizzeri and Persico, we deal with second-price auctions, private values, and more than two bidders. In contrast to Bikhchandani et al. and Maskin and Riley, we impose no regularity conditions on equilibrium strategies, aside from measurability: We characterize all equilibria.

Setup and Results

We assume that there are N > 2 risk-neutral bidders participating in a second-price sealed-bid auction for a single object, i.e. the highest bidder wins the object and pays the second highest bid. Ties are broken by assigning the object with equal probability to the highest bidders. Bidder is valuation vi is independently drawn from the cumulative distribution function Fi and only learned by bidder i. We assume that the distributions Fi , i = 1, . . . , N, of valuations have positive densities fi on the common support [0, v h ].1 We require measurable strategies to ensure that expected payos are well-dened for any strategy prole b() = (b1 (), . . . , bN (()). Our results extend (with only notational changes) to mixed strategies.
We could allow distributions with mass points, and also with correlated values provided the distribution of each bidders values, conditional on each prole of values for the other bidders, has full support.
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Proposition 1 Consider the second-price sealed-bid auction with independent private values and N 3 bidders. Suppose the distributions Fi , i = 1, . . . , N, of valuations have positive densities fi on the common support [0, v h ]. A strategy prole is a Nash equilibrium if it satises: There is a such that b 1. any bidder with valuation v > bids his valuation, b 2. if < v h , then there is one bidder who bids at whenever his valuation v satises v < b b b, and if v h then there is one bidder who bids at or above for any valuation v, b b 3. all other bidders bid 0 whenever their valuation v is in [0, b). Conversely, every equilibrium satises these conditions up to changes of the bid functions on a set of measure zero of buyers valuations. To check that these strategies are equilibria, it suces to show that there is no gain from deviating to the dominant strategy of always bidding ones valuation. This holds trivially for valuations in [ v h ]. For valuations v [0, raising ones bid from zero to ones valuation b, b) leaves the probability of winning at zero; lowering ones bid from to ones valuation aects b neither price nor the probability of winning. For the converse, the key insight is that positive bids less than the maximum valuation by one bidder have a contagious eect on other bidders. In any equilibrium, if a bidder has valuation v and bids bi (v) = v, then the probability that the highest rival bid lies between v and bi (v) must be zero. If one bidder bids near b (0, v h ) with positive probability, then no bidder always bids higher than b regardless of his valuation because otherwise some bidder would win with positive probability in situations where the price exceeds his valuation. Since everyone bids lower than b some of the time, bids above b win with positive probability, whereas bids below b lose with positive probability. This implies that bidders with valuations above b prefer to bid above b. For each bidder, if there are no gaps in the distribution of rival bids above b, then the bidder must bid his valuation (i.e. bi (v) = v). With only two bidders it is possible to have a gap in the distribution of bids above b, where one bidder bids at the upper end and the other at the lower end of the gap for all valuations in the gap.2 A third bidder, however, strictly prefers to
In the two bidder case, Blume and Heidhues [2001] show that the entire set of equilibria can be characterized by a set of intervals over which either both bidders almost always bid their values or one bidder bids at the lower end and the other bidder at the upper end of the interval for almost all values in the interval.
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bid inside such a gap. Hence, with three or more bidders, for any individual, there are no gaps in the distribution of rival bids between b and v h . Thus, as soon as one bidder makes bids near b with positive probability, all bidders must bid their valuations above b. Finally, if there was some other b (0, b) such that some bidder bids near b with positive probability then the argument duplicates with b taking the role of b. A positive reserve price initiates contagion just like positive bids do for Proposition 1. With a reserve price r > 0, bidders are required to abstain or bid (weakly) above the reserve price. The object is sold to the highest bidder at a price equal to the maximum of the second highest bid and r. No bidder always bids higher than r regardless of his valuation because otherwise some bidder would win with positive probability in situations where the price exceeds his valuation. Therefore for anyone bidding above r, there is positive probability that he wins and pays r. This implies that bidders with valuations above the reserve price prefer to bid above the reserve price. For each bidder, if there are no gaps in the distribution of rival bids above the reserve price then the bidder must bid his valuation (i.e. bi (v) = v). Exactly as before, with at least three bidders there can be no gaps in the distribution of rival bids. Thus all bidders must bid their valuations above r. Hence, with any positive reserve price equilibrium is unique. The formal proof is a minor variation of arguments used in Lemmas 1 to 5 in the appendix, and thus omitted. Corollary 1 Consider the second-price sealed-bid auction with independent private values and N 3 bidders. Suppose the distributions Fi , i = 1, . . . , N, of valuations have positive densities fi on the common support [0, v h ], and the seller sets a reserve price r (0, v h ). Up to changes of the bid functions on a set of measure zero, a strategy prole is a Nash equilibrium if and only if any bidder with valuation v < r does not bid, and any bidder with valuation v > r bids his valuation.

Appendix: Proof of Proposition 1

To prove Proposition 1, we need the following facts about equilibria. Lemma 1 Let Ui+ equals zero. 3 Ui be the set of valuations v for which bi (v) > v bi (v) < v . Then, for

almost all v Ui+ v Ui the probability that the highest rival bid lies in (v, bi (v)] [bi (v), v)

Proof: For a given valuation v, the outcome from v < bi (v) (v > bi (v)) diers from the outcome of i bidding his valuation only whenever the highest rival bid lies in the interval (v, bi (v)] ([bi (v), v)) and i wins (loses). In this event i prefers bidding his valuation because otherwise he wins (loses) at a price that exceeds (is less than) his valuation. interval [c, c ] interior if 0 < c c < v h . Lemma 2 If bidder bids in an interior interval [c, c ] then no bidder bids above c with probi ability one. 2 We will say that bidder i bids in an interval [c, c ], if Prob{bi (v) [c, c ]} > 0. We call the

Proof: By assumption, bidder does not bid above c with probability one. Suppose bidder i i = bids above c with probability one. Then he must bid above c for almost all v [0, c]. i Since v < c < c < bi (v) for almost all v [0, c], by Lemma 1 the probability that the highest rival bid is in (v, bi (v)] must be zero for almost all v [0, c]. Since, bids in [c, c ], this requires i that the probability that bi (v) is the winning bid is zero for almost all v [0, c]. This implies that there exists at least one rival j = i, such that Prob{bj (vj ) > bi (vi )|vi = v} = 1 for almost i, all v [0, c]. Thus bidder j must bid above c for almost all v [0, c], and the same argument that applied to bidder i now applies to j. Therefore, by induction, there must be a sequence {in } of bidders such that Prob{bn+1 (vn+1 ) > bn (vn )|vn = v} = 1 for almost all v [0, c]. n=1 This cannot be the case since there is only a nite number of bidders. 2

Lemma 3 If bidder bids in an interior interval [c, c] then there does not exist an interval i (d, d) with c d < v h and Prob{bi (v) (d, d)} = 0 i. Lemma 3 says that the support of strictly positive bids below the maximum valuation is connected. The proof by contradiction is in three steps: Assuming that there is gap in the support, we (1) show that there is a maximal gap, (2) show that one can always nd a bidder without whom the gap remains maximal, and who does not have a mass point at either end of the gap, and (3) show that this bidder has a strict incentive to bid in the gap, a contradiction. Proof: Suppose, such an interval (d, d) exists. Let X be the collection of open intervals (a, b) that contain (d, d) and satisfy Prob{bi (v) (a, b)} = 0 i. The union of intervals in X, denoted U (X), is an open interval. With the standard topology, U (X) has a countable basis. Thus, it is 4

a Lindelf space; i.e., every open covering of U has a countable subcovering (Munkres [1975], p. o 191). Hence, U (X) is a countable union of elements of X. A countable union of sets of measure zero has measure zero. Hence, U (X) is an element of X and therefore maximal in X. Denote U (X) by (e, e). Note that e c since bidder bids in [c, c] with positive probability. i Given that (e, e) is a maximal interval in X, there must be (by construction) a bidder for whom e is the lower bound of an interval over which he does not bid with positive probability. Call this bidder i and if there is a choice, choose bidder i such that he has a mass point at e. Likewise, there must be a bidder for whom e is the upper bound of an interval over which he does not bid with positive probability. Call him bidder j and if there is a choice choose bidder j such that he has a mass point at e. Choose a bidder k = i, j. If i does not have a mass point at e, then by construction neither does k. Thus, if k has a mass point at e, so does i. But in that case, Lemma 2 implies that e has positive probability of being the highest bid. From ks perspective, this implies that e has positive probability of being the highest rival bid and hence Lemma 1 implies that k does not bid at or below e for almost all valuations above e and does not bid at or above e for almost all valuations below e. Hence, bidder k does not have a mass point at e, and similarly does not have a mass point at e. Since (e, e) is a maximal interval over which ks rivals dont bid, Lemma 1 rules out that there is a positive measure set of valuations in (e, e) for which he bids either below e or above e. Since k doesnt have a mass point at either e or e, we have a contradiction. the maximum valuation is connected. Lemma 4 If some bidder i bids in an interior interval [c, c], then there does not exist an interval (d, d) with c d < d v h and a bidder j such that Prob{bj (v) (d, d)} = 0. 2 Lemmas 4 and 5 show that for each single bidder the support of strictly positive bids below

Proof: Suppose such an interval exists for bidder j. By Lemma 3, for every (a, b) (d, d), there is at least one bidder bidding with positive probability in (a, b). By assumption, this is not bidder j. Together with Lemma 2, this means for all v (d, d) and all > 0, every interval (v , v) and (v, v + ) has a positive probability of containing the highest rival bid. Hence, Lemma 1 requires that the set of valuations in (d, d) for which bj (v) = v has measure zero, a contradiction. 2

Lemma 5 If some bidder i bids in an interior interval [c, c], then every bidder bids his valuation for almost all v > c. 5

Proof: By Lemma 4, for every bidder j every interval (a, b) (c, v h ) has a positive probability of containing the highest rival bid. Hence, Lemma 1 requires that the set of valuations in (c, v h ) for which bj (v) = v has measure zero. 2

Lemma 6 If no bidder bids in [v h , ) with positive probability, then there exists [0, v h ) b such that bidders with valuations above almost always bid their valuations and almost all bids b less than equal zero. b

Proof: By Lemma 1 it is impossible for all bidders to bid zero with probability one. Since some bidder bids in (0, v h ) with positive probability, there exists an interior interval [c, c] in which some bidders bid. Thus, by Lemma 5 there exists an interval (c, v h ) on which all bidders almost always bid their valuations. Denote the maximal interval with respect to this property by ( v h ). Since ( v h ) is a maximal interval, every subinterval ( + ) has positive probability b, b, b, b of containing the highest rival bid. Therefore by Lemma 1, no bidder bids above with positive b probability for valuations v (0, If someone for valuations v (0, bid in [c1 , c2 ] (0, b). b) b) with positive probability, then by Lemma 5 everyone would almost always bid their valuations above c2 , which would contradict ( v h ) being maximal. b, 2 Lemma 7 If there is a positive probability of bids in the interval [v h , ), then there is one bidder who bids in [v h , ), with probability one while all others bid 0 with probability one.

Proof: If more than one bidder bids in [v h , ) with positive probability, then for at least one of these bidders, say bidder i, there is a positive measure set of valuations v such that bi (v) > v and the probability that the highest rival bid is in (v, bi (v)] is positive. This is ruled out by Lemma 1. Hence, at most one bidder bids in [v h , ) with positive probability. If no one bids i in (0, v h ), then must bid in [v h , ) with probability one. Otherwise, all bidders would bid i zero with positive probability, contradicting Lemma 1. Furthermore, if no one bids in (0, v h ) with positive probability, rivals must be bidding zero with probability one, since there can is not be two bidders bidding at or above v h with positive probability. If some bidder j bids in the interval (0, v h ) with positive probability, then he bids in an interior interval [c, c] (0, v h ). Hence, by Lemma 5 every bidder bids his valuation almost everywhere over the non-empty 6

interval (c, v h ]. Thus Lemma 1 implies that no bidder bids above v h for almost all values v < c. Hence, in this case no bidder bids above v h with positive probability, a contradiction. 2

Proof of Proposition 1: We showed suciency in the text. Thus, we are left to show that there are no other equilibria. In case some bidder bids above v h with positive probability, the proposition follows from Lemma 7. Otherwise, it follows from Lemma 6 that there exists a [0, v h ) such that bidders b with valuations above almost always bid their valuations and almost all bids less than equal b b zero. It remains to show that one bidder almost always bids for valuations in [0, and all b b) others almost always bid zero for valuations in [0, Since each interval ( + ) has positive b). b, b probability of containing the highest rival bid, Lemma 1 implies that no bidder bids above for almost all values v [0, Because by Lemma 6 no bidder bids in (0, with positive b b). b) probability, all bidders must have a mass point at zero, or both. Observe that if more than b, one bidder has a mass point at for each bidder has positive probability of being the highest b, b rival bid. This is ruled out by Lemma 1 because bidders bid for a positive measure set of b values v < Next observe that if all bidders bid zero with positive probability, then for each b. bidder zero has positive probability of being the highest rival bid. This is ruled out by Lemma 1 because bidders bid zero for a positive measure set of values v > 0. Hence, one bidder must bid for almost all v [0, and all other must bid zero for almost all v [0, b b) b). 2

References
Bikhchandani, S. and J.G. Riley [1991], Equilibrium in Open Common Value Auctions, Journal of Economic Theory, 53, 101-130. Bikhchandani, S. and J.G. Riley [1993], Equilibrium in Open Auctions, UCLA Working Paper. Bikhchandani, S., P.H. Haile and J.G. Riley [2002], Symmetric Separating Equilibria in English Auctions, Games and Economic Behavior, 38, 19-27. Blume, A. and P. Heidhues [2001], All Equilibria of the Vickrey Auction, University of Pittsburgh and Social Science Research Center (WZB) Working Paper available at <www.wz-berlin.de/ heidhues>.

Lizzeri, A. and N. Persico [2000], Uniqueness and Existence of Equilibrium in Auctions with a Reserve Price, Games and Economic Behavior, 30, 83-114. Maskin, E. and J. Riley [1996], Uniqueness in Sealed High Bid Auctions, Harvard University and UCLA Working Paper. Milgrom, P. [1981], Rational Expectations, Information Acquisition, and Competitive Bidding, Econometrica, 49, 921-943. Munkres, J.R. [1975] Topology: A First Course, Englewood Clis, NJ: Prentice-Hall, Inc. Plum, M. [1992], Characterization and Computation of Nash-Equilibria for Auctions with Incomplete Information, International Journal of Game Theory, 20, 393-418. Vickrey, W. [1961], Counterspeculation, Auctions and Competitive Sealed Tenders, Journal of Finance, 16, 8-37.