Monday, October 18, 2010

Name That Model

Whenever the renters of self-storage units default on their payments, the owner has the right to sell the contents of the units to the highest bidder. In some states, potential buyers are prohibited from examining the detailed contents of the units; rather, they are merely allowed to "peek" inside before the bidding process starts.

The type of auction described above is an example of a more general situation that economists have studied and modeled. Can you identify the relevant model? What does the model suggest is the optimal bidding strategy in such situations? Winners of such auctions are often said to suffer from a particular fate--can you name it?

Congratulations to Yuan Tao--a three-time winner this semester--for correctly identifying the common value auction (and its associated "winner's curse").


Zhongtian said...

Is it a bidding model?

TAO YUAN said...

“All-or-nothing choice” model, which means that when a monopolist can dictate both price and quantity, buyers confront “paying the full price” or “getting nothing at all”, just like the situations about hosting the Olympics and World Cup.

Average bid is generally lower than the actual money value while the winning bid generally exceeds the money value.

So the optimal bidding strategy in such situation is to avoid being the “winner”, because Winner of such auctions are often said to suffer from “Winner curse”, indicating that the winner’s bid is higher than the true return.

Greg Delemeester said...

@Zhongtian: No.

@Yuan Tao: The last part of your answer is correct, but the first two parts are not.

TAO YUAN said...

The name of the model is “Common value auction”, which indicates the value of the object is approximately the same for all rational bidders, although none has the perfect information about what the exact value is.

The model suggests that the optimal bidding strategy is to bid on the average level. Bidders can refer to previous bidding information and get a basic concept about the value of the item.