Auctions 1.

Auctions are another way to organize

exchange.
The perspective of this course is that the way
exchange is organized reflects the historical
bargaining strengths of the usual buyers, sellers and
intermediaries.
Auctions are ancient mechanisms. In ancient Rome
(before the Common Era), Nobles sold their old
furniture using a public auction. “Auctions were the
normal way for private individuals to sell their used
belongings.” (p. 146, A History of Private Life: From
Pagan Rome to Byzantium, P. Veyne, ed.). In fact, the
word auction is derived from the Latin for to increase -
suggesting that these Romans used the English
(ascending price) style of auction.
Auctions 2.
The study of auctions usually starts with a taxonomy.
Major types of auctions:
• Sealed Bid
• English (Open Outcry)
• Dutch
A sealed bid auction may be a
• First-Price Auction, or a
• Second-Price Auction
We also should ask whether the auction is for a single
good (e.g., a Picasso), or multiple units (e.g., T-Bills
or wine).
Auctions 3.
To understand why auctions might be used, we have
to allow for the possibility that the potential
buyers have some information about the item(s)
being auctioned that the seller does not have, and
vice-versa.
This is perhaps most obvious when the item has
private value attributes. In this case, the seller
wants to get a price equal to the highest private
value amongst all potential bidders.
Generally, we assume that the seller has the choice
of mechanism. Although increasingly, we
envision that mechanisms themselves will be a
basis for competition.
Auctions 4.
Finance is generally interested in common
value settings. The item’s value derives
solely from its worth to others.
Ashenfelter calls our attention to the price
discovery aspect of auctions (he calls this
an externality - p. 31). As with any
externality, a concern is that the providers
of a positive externality derive private
benefits sufficient to lead to create enough
of the externality.
Auction Game 1.
The item being auctioned in our auction game is a lease
on offshore oil drilling rights - auctioned by the
government. We all know that the average value of
such leases is $100 million. Also, the standard
deviation of the lease values is $30 million. (And that
a Normal Distribution is a good approximation of the
values’ probabilistic structure.)
Each bidder receives a signal of the value of the
particular lease to be auctioned. This signal was
obtained by your geologists and other experts. Your
data shows that these signals are correct on average,
but that they have a standard deviation of $15 million
around the true value (again a Normal distribution is
appropriate).
Auction Game 2.
In addition, we all know the number of bidders,
who are all in the same boat - their signals are
independent of one another (although each
comes from the same distribution - whose mean
is the true value and standard deviation is $15
million.)
The object of each bidder is to win the lease
by paying no more for it than it is worth. If
you win the auction and pay a price of $90,
and the lease is worth $82, you lose $8
million.
Auction Game 3.
The following types of auctions will be
conducted in this first offshore oil lease
scenario:
– First-Price Sealed Bid
– Second Price Sealed Bid
– English
– Dutch
The Government always specifies a Reserve
Price, but it will not disclose what it is.
Treasury Auctions
The largest auction in the world is the weekly
auction of US Treasury obligations. The
Treasury auctions an unknown amount of
90-Day Bills. Before the auction, these Bills
trade on a When-Issued basis. After the
auction they trade in a secondary market.
For the most part, the bidders are primary
dealers. These dealers have some private
information in the form of customer orders.
Treasury Auctions 2.
The auction is a sealed-bid form. The
Treasury has used two types of auctions:
– Uniform Price, and
– Discriminating Price.
Bidders are allowed to make noncompetitive
or competitive bids. In a discriminating
price auction, noncompetitive bids are sold
at the value-weighted average of winning
bids.
On November 2, 1998 the Treasury switched
to a uniform-price format for all auctions.
Treasury Auctions 3.
Bidders submit how much they want at what
price.
In a uniform price auction, the Treasury starts
at the highest price, and goes down until all
units are sold. All units are sold at this
(lowest) clearing price.
In a discriminatory auction, the Treasury
similarly ranks the bids, but here each
winning bidder pays the price bid for that
quantity.
Treasury Auctions 4.
In this setting, the information available to
bidders comes from their customer demand.
The primary dealers will generally enter the
auction with a short position, and cover this
in the auction. (This is why a short squeeze
is a concern.)
Historically, under the uniform price auctions,
the price is, on average, higher in the
secondary market then the non-competitive
bid price. (Average difference in yields: 3-4
basis points.) Although Nandi (p. 12)
suggests that this is not a robust finding.
 Natural Experiments
Nandi refers to “natural experiments” in foreign
countries.
Mexico: In July, 1990, Mexico switched to a
uniform-price auction in Treasury auctions.
Define the auction profit margin to be the
proportional difference between the secondary
market price and the price paid at auction. In
the 30-Day securities, the average profit margin
across 58 bidders (181 auctions) in 8-86—6-90
is 1.84 bps. This number is –0.3 in the 26
uniform-price auctions, post July 1990.
(Statistically significant difference.)
 The Mexican Experiment
Umlauf also found evidence that 6 large bidders
collude in Mexico. The switch to uniform-price
format hurt these large institutions, the impact
on small bidders (not part of the “ring”) of the
switch was less.
An interesting feature of some foreign Treasury
auctions (incl. Mexico) is that the Treasury
reserves the right to cancel an auction. In
Mexico, this happens mostly because of a lag
between bid submission and the auction, and a
drop in the interest rate environment during this
period.
Market Efficiency
Recall the market making game and the
auction game. One question we can ask
about both is how (private) information
becomes impounded in the price.
In the market making game, the informed
trader is able to trade at prices that do not
(yet) reflect her information. This can
obviously create an incentive to find
information. Note that in the MMG whether
the information is good or bad is irrelevant -
owing to no short-selling constraints.
Information Revelation
Recall the information structures from the
market-making game (mmg) and the
auction game (ag). In ag, no bidder has
better information than any other bidder.
In mmg, the insider had monopoly
access to valuable information. The
presence of liquidity traders prevented
market failure.
Information Revelation 2.
In ag all bidders are equally well informed.
There is less liquidity since no dealer
stands willing to buy/sell. The auction is
an attempt to tease out the information
that the bidders have.
Of course the auction house attempts to
“create liquidity” in the fashion of a
dealer.
 Price Discovery

A corollary to this discussion is the value of

information. In both the mmg and ag
information was provided free of charge. In
reality it is costly to collect and process
information.
The structure of the mechanism can impact the
amount of effort and expense dedicated to
information collection, which in turn may have
important implications for market efficiency.