Auctions 1.

1
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.

2
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).

3
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.

4
Auctions 4.

• Finance is generally interested in common value
  settings. The items 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.

5
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).

6
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.

7
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.

8
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.

9
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.

10
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.

11
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.

12
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 8-866-90 is
  1.84 bps. This number is 0.3 in the 26
  uniform-price auctions, post July 1990.
  (Statistically significant difference.)

13
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.

14
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.

15
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.

16
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.

17
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.