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Auctions under Payoff Uncertainty: The Case with Heterogeneous Bidder-Aversion to Downside Risk

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  • Audrey Hu

    ()
    (University of Amsterdam)

  • Liang Zou

    (University of Amsterdam)

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    Abstract

    This paper characterizes the optimal first-price auction (FPA) and second-price auction (SPA) for selling rights, contracts, or licenses that involve ensuing payoff uncertainty for the winning bidder. The distribution of the random payoff is common knowledge, except that bidders have private degrees of aversion to downside-risk. In this model, the optimal FPA entails a lower reserve price, a higher expected revenue, and higher expected utilities for at least some or all bidders than the optimal SPA does, which suggests that FPA dominates SPA in terms of both allocative and Pareto efficiency. Increasing risk or risk aversion generally leads to lower equilibrium bids.

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    Bibliographic Info

    Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 08-044/1.

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    Date of creation: 21 Apr 2008
    Date of revision: 22 Apr 2008
    Handle: RePEc:dgr:uvatin:20080044

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    Web page: http://www.tinbergen.nl

    Related research

    Keywords: auction; downside risk; risk aversion; payoff uncertainty; allocative efficiency; Pareto efficiency;

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    1. Vincent P. Crawford & Nagore Iriberri, 2007. "Level-k Auctions: Can a Nonequilibrium Model of Strategic Thinking Explain the Winner's Curse and Overbidding in Private-Value Auctions?," Econometrica, Econometric Society, vol. 75(6), pages 1721-1770, November.
    2. Milgrom,Paul, 2004. "Putting Auction Theory to Work," Cambridge Books, Cambridge University Press, number 9780521551847, October.
    3. Jacob K. Goeree & Theo Offerman, 2000. "Efficiency in Auctions with Private and Common Values: An Experimental Study," Virginia Economics Online Papers 347, University of Virginia, Department of Economics.
    4. SHALEV, Jonathan, 1997. "Loss aversion equilibrium," CORE Discussion Papers 1997023, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    5. Bawa, Vijay S., 1975. "Optimal rules for ordering uncertain prospects," Journal of Financial Economics, Elsevier, vol. 2(1), pages 95-121, March.
    6. Cox, James C. & Smith, Vernon L. & Walker, James M., 1982. "Auction market theory of heterogeneous bidders," Economics Letters, Elsevier, vol. 9(4), pages 319-325.
    7. Bawa, Vijay S. & Lindenberg, Eric B., 1977. "Capital market equilibrium in a mean-lower partial moment framework," Journal of Financial Economics, Elsevier, vol. 5(2), pages 189-200, November.
    8. Goeree, Jacob K. & Offerman, Theo, 2003. "Winner's curse without overbidding," European Economic Review, Elsevier, vol. 47(4), pages 625-644, August.
    9. Eso, Peter, 2005. "An optimal auction with correlated values and risk aversion," Journal of Economic Theory, Elsevier, vol. 125(1), pages 78-89, November.
    10. Jacob K. Goeree & Theo Offerman, 2000. "Competitive Bidding in Auctions with Private and Common Values," Tinbergen Institute Discussion Papers 00-044/1, Tinbergen Institute.
    11. Bawa, Vijay S, 1976. "Admissible Portfolios for All Individuals," Journal of Finance, American Finance Association, vol. 31(4), pages 1169-83, September.
    12. Cox, James C & Smith, Vernon L & Walker, James M, 1988. " Theory and Individual Behavior of First-Price Auctions," Journal of Risk and Uncertainty, Springer, vol. 1(1), pages 61-99, March.
    13. Benartzi, Shlomo & Thaler, Richard H, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 73-92, February.
    14. Moore, John, 1984. "Global Incentive Constraints in Auction Design," Econometrica, Econometric Society, vol. 52(6), pages 1523-35, November.
    15. Eso, Peter & Futo, Gabor, 1999. "Auction design with a risk averse seller," Economics Letters, Elsevier, vol. 65(1), pages 71-74, October.
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