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A Dynamic Mechanism and Surplus Extraction Under Ambiguity

  • Subir Bose
  • Arup Daripa

    (Department of Economics, Mathematics & Statistics, Birkbeck)

In the standardindependentprivate values (IPV)model, each bidder’s beliefs about the values of any other bidder is represented by a unique prior. In this paper we relax this assumption and studythe question of auction design in an IPV setting characterizedby ambiguity: bidders have an imprecise knowledge of the distribution of values of others, and are faced with a set of priors. We also assume that their preferences exhibit ambiguity aversion. We show that a simple variation of a discrete Dutch auction can extract almost all surplus. This contrasts with optimal auctions under IPV without ambiguity as well as with optimal static auctions with ambiguity-in allofthese, types other than the lowestparticipatingtype obtain a positive surplus. And,unlike the well-known Cremer-McLean mechanism, our modifiedDutch mechanism satisfies limited liability. An important point of departure is that the modified Dutch mechanism we consider is dynamic rather than static, establishing that under ambiguity aversion–even when the settingis IPV in all other respects–a dynamic mechanism could have additional bite over its static counterparts.

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Paper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0716.

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Date of creation: Sep 2007
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Handle: RePEc:bbk:bbkefp:0716
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