Auctions

2nd Price Sealed Bid Auction

• bidders submit sealed bids
• Highest bidder wins

• Price = 2nd highest bid

• Also called “Vickrey Auction”

• Main feature: The optimal strategy is to bid

• Enables the auctioneer to extract true

valuations out of the bidders.
Example
• Consider 3 bidders

Valuations:

Bids:

Bids:

• Who wins in scenario 1? What’s the sale price?

• Who wins in scenario 2? What’s the sale price?
• Bidder 3: Keep track of to determine if I win and how much I pay.
Optimal Bidding Strategy
B3 conducts the following thought experiment

Suppose : payoff 0

payoff either 0 or (-)

payoff 0

Suppose : payoff 0

payoff 0

payoff 0

Suppose : payoff either 0 or

payoff

payoff

In all scenarios bidding is weakly dominant. The argument can be generalized to bidders.

Result: In a second price sealed bid auction player with valuation optimally bids .
Properties
• Self-revelation (Value discovery): Private values revealed via

truthful bidding.

• Pareto Efficiency: Who wins the auction? Is it Pareto efficient?

• Analogous to English Auction: Bidders bid up to their valuations

and pay the second highest bid.

• Real Life: Ebay Auctions with proxy bidding

– Difference: Reserve price (more below)
Summary: Private Value Auctions
• Fill out the table below

Strategy? Who wins? Sale Price? Efficient?

English

Dutch

1st Price

2nd Price
Revenue Equivalence
• Consider a private value auction participated by bidders with values

from

• 1st price auction (or Dutch auction)

– Bid: Pays:

• 2nd price auction (or English auction)

– Pays: 2nd max of

• Which one generates more revenue?

• Answer: They are the same!

– “Revenue Equivalence Theorem”
Sketch of the proof
Order Statistics

• Let be random variables from

• Rank them from the lowest to highest:

• Expected value of is given by:

• Maximum:

• 2nd maximum:
Sketch of the proof
• 1st price auction

• 2nd price auction

• They are the same!

• Revenue Equivalence Theorems are more general – not just the uniform

distribution, not just 1st and 2nd price auctions.

• Question: How can they generate the same revenue if one pays the second

highest bid in one format and the highest bid in the other format?
Reserve Price
• Private value auction participated by 2 bidders. Each

bidder’s value is either £50 (with prob. ½ ) or £20 (with

prob. ½).
• Calculate the seller’s expected revenue with no reserve

price.
• Calculate the seller’s expected revenue with reserve price

£49.
• Lesson: Adding a reserve price improves revenue.
Common Value Auction
• Private value auction: each person has a different

valuation, ; knows what is; but does not know other

valuations.

• Example: Objects for which tastes greatly vary (e.g. art).

Values are certain, no surprise after the purchase!

• Common Value auction: item for sale is identical

amongst bidders, but bidders have different

information about the item's value.

• Example: A jar full of quarters is auctioned off. Bidders

don’t know how much money is in, so they go with

their estimates.
Common Value Auction
• Governments auction off the

drilling rights for an oil field.

– Bidders don’t know how much

oil there is in the field.

• De Beers sells diamonds at

regularly scheduled “sights”.

• Clients given the opportunity

to have a sight; then they bid

against each other.

Modelling Common Value Auctions
• True value =
• Bidder receives signal about (“estimate”)

• Bidders 1 and 2 draw pessimistic signals

• Bidders 3 and 4 draw optimistic signals
Modelling Common Value Auctions
• Suppose the seller uses an English auction (or 2nd price)
– With private values:

• Should bidders treat their signals as true values?

• Suppose they do. Then

• Who wins the auction? Should they be happy about it?

Winner’s Curse
• In a common value auction the winner is
the bidder with the most optimistic
evaluation of the asset and therefore will
tend to overestimate and overpay.
• First popularized by:
Capen, Clap, Campbell (1971) "Competitive Map of the Outer Continental Shelf
Bidding in High-Risk Situations”, Journal of
Petroleum Technology

• Main finding: Oil companies suffer low

returns after the Outer Continental Shelf oil
lease auctions.
Winner’s Curse
• Naïve bidder: Treats signal as

• Sophisticated bidder: Understands the

winner’s curse; thus shades bid.

• Regardless of the auction format, in a

common value auction, the optimal strategy

is to shade by bidding less than the signal.

• Number of bidders: as shade more

– Reason: Which one is more worrying: You won

against 3 people or 100 people?

• Risk aversion Aggressive shading