Auction Theory

an introduction
DAI Hards
October 16th
Introduction
• Auctions are the most widely-studied economic
mechanism.
• Auctions refer to arbitrary resource allocation problems
with self-motivated participants: Auctioneer and bidders
• Auction (selling item(s)): one buyer, multiple bidders)
e.g. selling a cd on eBay
• Reverse Auction (buying item(s)): one buyer, multiple
sellers
e.g. procurement
• We’ll discuss auction, though the same theory holds for
reverse auction
Historical note

• Reports that auctions was used in Babylon

500 B.C.
• 193 A.D. After having killed Emperor
Pertinax, Prætorian Guard sold the Roman
Empire by means of an Auction
Where auctions are used
nowadays?
• Treasury auctions (bill, notes, Treasury bonds, securities)
• Has been used to transfer assets from public to private
sector
• Right to drill oil, off-shore oil lease
• Use the EM spectrum
• Government and private corporations solicit delivery
price offers of products
• Private firms sell products (flowers, fish, tobacco,
livestock, diamonds)
• Internet auctions
Questions
• Information problem: the seller has usually
incomplete information about buyers’ valuations
(else, he just need to set the price as the
maximum valuation of the buyer)  what
pricing scheme performs well even in incomplete
information setting (is auction better suited for a
given problem? Does a type of auction yield
greater revenue?)
• For the buyer, what are good bidding strategies?
Terminology
• Criterion of comparison:
– Revenue: expected selling price
– Efficiency: the object ends up in the hands of the person who values it
the most (resale does not yield to efficiency)
• Private Value: no bidder knows with certainty the valuation of the other
bidders, and knowledge of the other bidders’ valuation would not affect the
value of the particular bidder
• Pure common value: the actual value is the same for ever bidders
but bidders have different private information about the what that value
actually is (e.g. auction of an oil field and the amount of oil is unknown, different
bidders have different geological signals, learning another signal would change the
valuation of a bidder).
• Correlated value: agent’s value of an item depends partly on its own
preferences and partly on others’ values for it
Agents care about utility, not
valuation

• Auctions are really lotteries, so you must compare

expected utility rather than utility.
• Risk attitude speak about the shape of the utility
function:
– linear utility function refers to risk-neutrality
 optimize her/his expected payoff
– Concave utility function refers to risk-aversion (u’>0 and u’’<0)
– convex utility function refers to risk-seeking (u’>0 and u’’>0)
• The types of utility functions, and the associated risk
attitudes of agents, are among the most important
concepts in Bayesian games, and in particular in
auctions. Most theoretical results about auction are
sensitive to the risk attitude of the bidders.
Outline

• Single-item Auctions
– Common auctions forms
– Equivalence between auctions
– Revenue equivalence
• Multi-unit Auction
• Multi-item Auction
Single Item Auction
English
(first-price open-cry = ascending)
• Protocol: Each bidder is free to raise his bid. When no bidder is
willing to raise, the auction ends, and the highest bidder wins the
item at the price of his bid
• Strategy: Series of bids as a function of agent’s private value, his
prior estimates of others’ valuations, and past bids
• Best strategy: In private value auctions, bidder’s dominant
strategy is to always bid a small amount more than current highest
bid, and stop when his private value price is reached
• Variations:
– In correlated value auctions, auctioneer often increases price at
a constant rate or as he thinks is appropriate (japonese auction)
– Open-exit: Bidder has to openly declare exit without re-entering
possibility => More info to other bidders about the agent’s
valuation
First-price sealed-bid
• Protocol: Each bidder submits one bid without knowing
others’ bids. The highest bidder wins the item at the
price of his bid
• Single round of bidding
• Strategy: Bid as a function of agent’s private value and
his prior estimates of others’ valuations
• Best strategy: No dominant strategy in general
• Strategic underbidding & counterspeculation
• Can determine Nash equilibrium strategies via common
knowledge assumptions about the probability
distributions from which valuations are drawn
• Variant: kth price
Example

• Values are uniformly distributed on [0,1]

The equilibrium bid is (N-1)*x/N
Where
– x is the valuation of the bidder
– N is the number of bidders
(proof)
Dutch (descending)
• Protocol: Auctioneer continuously lowers the price until a bidder
takes the item at the current price
• Strategically equivalent to first-price sealed-bid protocol in all
auction settings
• Strategy: Bid as a function of agent’s private value and his prior
estimates of others’ valuations
• Best strategy: No dominant strategy in general
– Lying (down-biasing bids) & counterspeculation
– Possible to determine Nash equilibrium strategies via common
knowledge assumptions regarding the probability distributions of others’
values
– Requires multiple rounds of posting current price
• Dutch flower market, Ontario tobacco auction, Filene’s basement,
Waldenbooks
Vickrey (= second-price sealed bid)
• Protocol: Each bidder submits one bid without knowing (!) others’
bids. Highest bidder wins item at 2nd highest price
• Strategy: Bid as a function of agent’s private value & his prior
estimates of others’ valuations
• Best strategy: In a private value auction with risk neutral bidders,
Vickrey is strategically equivalent to English. In such settings,
dominant strategy is to bid one’s true valuation
– No counterspeculation
– Independent of others’ bidding plans, operating environments,
capabilities...
– Single round of bidding
• Widely advocated for computational multiagent systems
• Old [Vickrey 1961], but not widely used among humans
• Revelation principle --- proxy bidder agents on www.ebay.com,
www.webauction.com, www.onsale.com
All Pay (e.g.lobbying activity)

• Protocol: Each bidder is free to raise his bid. When no

bidder is willing to raise, the auction ends, and the
highest bidder wins the item. All bidders have to pay
their last bid
• Strategy: Series of bids as a function of agent’s private
value, his prior estimates of others’ valuations, and past
bids
• Best strategy: ?
– In private value settings it can be computed (low bids)
• Potentially long bidding process
• Variations
– Each agent pays only part of his highest bid
– Each agent’s payment is a function of the highest bid of all
agents
In a Nutshell

Sealed Bid Format Open Format

Weak
Second-Price Sealed Bid
English Auction
i.e Vickrey
Private Value

First-Price Sealed Bid Dutch Descending Price

Strong
Setting for Private Value Auctions
N potential bidders. Bidder i is assigned a value of Xi to the
object
– Each Xi is i.i.d. on some interval [0,ω] according to the
cumulative distribution F
– Bidders I knows her/his xi and also that other bidders values are
i.i.d. according to F
– Bidders are risk neutral (seek to maximize their expected
payoffs)
– The number of bidders and the distribution F are common
knowledge.
• Symmetry
The distribution of values is the same for all bidders. WE can
consider that all bidders are alike, hence an optimal bidding
strategy for one should also be an optimal strategy for the
others  symmetric equilibrium
Results for private value auctions

• Dutch strategically equivalent to first-price sealed-bid

• Risk neutral agents => Vickrey strategically equivalent to
English
• All four protocols allocate item efficiently (assuming no
reservation price for the auctioneer)
• English & Vickrey have dominant strategies  no effort
wasted in counterspeculation
• Which of the four auction mechanisms gives highest
expected revenue to the seller?
Assuming valuations are drawn independently & agents are risk
neutral: The four mechanisms have equal expected revenue!
Reserve Price in Private Values
• A seller can reserve the right to not sell the object if the price is
below a reserved price r
 Bidders with value x<r are excluded from the auction
 Bidders change their strategy (can be computed)
• A revenue maximizing seller should always set a reserve price r that
exceeds her or his valuation x0
Proof: compute the expected payoff of the seller, differentiate it with respect to the reserve price and
observe it the derivative is positive at x0

• Entry Fees: the auctioneer can use an entry fee: a nonrefundable

amount that the bidder has to pay to participate to the auction.
Note : there is a way to fix the entry fee such it is equivalent to using a reserved price as
far as the agents that are excluded are concerned.
• Trade-off: may improve revenue at the expense of efficiency (if seller
set a reservation price which is too high)
Revenue Equivalence Theorem
• In all auctions for k units with the following properties
– Buyers are risk neutral
– Private Value, with values independently and identically
distributed over [a,b] (technicality – distribution must be
atomless)
– Each bidder demands at most 1 unit
– Auction allocates the units to the k highest bids (efficiency)
– The bidder with the lowest valuation has a surplus of 0 (i.e. a
bidder with a value of 0 has an expected payment of 0)
a buyer with a given valuation will make the same
expected payment, and therefore all such auctions have
the same expected revenue
Application of the Revenue
Equivalence Theorem
Helps to find some equilibrium strategy
• Ex: compute the equilibrium bid in an all
pay auction or in a third price auction
• In the case where the number of bidders
is uncertain, we can compute the
equilibrium bid strategy for a first price
auction
 Revenue equivalence ceases to
hold if agents are not risk-neutral
• Risk averse Agents
– for bidders:
Dutch, first-price sealed-bid ≥ Vickrey, English
Compared to a risk neutral bidder, a risk averse bidder will
bid higher (“buy” insurance against the possibility of
loosing)
(utility of winning with a lower bid <utility consequence loosing the object)
– For auctioneer auctioneer:
Dutch, first-price sealed-bid ≤ Vickrey, English
• Risk-Seeking Agents
– The expected revenue in third-price is greater than the
expected revenue in second-price (English)
– Under constant risk-attitude: (k+1)-price is preferable to
k-price
Revenue equivalence ceases to
hold if it is not Private Value
Results for non-private value auctions
• Dutch strategically equivalent to first-price sealed-bid
• Vickrey not strategically equivalent to English
• All four protocols allocate item efficiently
• Winner’s curse: each bidder must recognize that she/he wins the
objects only if she/he has the highest signal, failure to take into
account the bad news about others’ signal can lead the bidder to pay
more than the prize it is worth.
– Common value auctions:
v˜ = E [ v | vˆ , b ( vˆ ) < b ( vˆ ), ..., b ( vˆ ) < b ( vˆ )]
1 1 2 1 N 1

– Agent should lie (bid low) even in Vickrey & English Revelation to
proxy bidders?
• Thrm (revenue non-equivalence ). With more than 2 bidders, the
expected revenues are not the same:
English ≥ Vickrey ≥ Dutch = first-price sealed bid
Results for non-private value
auctions
• Common knowledge that auctioneer has
private info
Q: What info should the auctioneer release ?
A: auctioneer is best off releasing all of it
• “No news is worst news”
• Mitigates the winner’s curse
The revelation principle
(mechanism Design)

• In a revelation mechanism agents are asked to report

their types (e.g.valuations for the good), and an action
(e.g. decision on the winner and his/her payment) will
be based the agents’ announcement.
• In general, agents may cheat about their types, but:

Any mechanism that implements certain behavior (e.g. a

good is allocated to the agent with the highest
valuation,v, and he pays (1-1/n)v) can be replaced by
another mechanism that implements the same behavior
and where truth-revealing is in equilibrium.
Multi-unit Auction
Auctions with multiple
indistinguishable units for sale
• Examples
– IBM stocks
– Barrels of oil
– Pork bellies
– Trans-Atlantic backbone bandwidth from NYC
to Paris
–…
Setting for sealed bid auctions

• Each bidder sends a “bid vector” indicating

how much she/he is willing to pay for each
additional unit
 Can be understood as a demand function
Value of the bid

Number of units
Pricing rules

Auctioning multiple indistinguishable units

of an item
• The discriminatory (or “pay your bid”)
auction
• The uniform price auction
• The Vickrey auction
Discriminatory auction

• Each bidder pays an amount equal to the

sum of his bids that are among the K
highest of the N*K bids submitted.
Uniform-price Auction

• Any price between the highest loosing bid

and the lowest winning bid is possible
 can choose the highest losing bid
Vickrey Auction
• Basic principle is the same as the Vickrey-
Clarke-Groves mechanism (see Mechanism
Design)
• A bidder who wins k units pays the k
highest losing bids of the other bidders
• For bidder i to win the kth unit, i’s kth
highest bid must defeat the kth lowest
competing bid
Some Open Auctions

• Dutch Auctions
• English Auctions
• Ausubel Auctions
 Multi-item auctions
multiple distinguishable items for
sale
Bundle bidding scenario
Bundle bidding scenario
Bundle bidding scenario

(console, television, cd player $1000)

Bundle bidding scenario

(television, music system, computer, $1600)

Bundle bidding scenario

(cd player, console, music system $400)

Bundle bidding scenario

((console, television, cd player $1000),

(television, music system, computer, $1600),
(cd player, console, music system $ 400))
Bundle bidding scenario

((Computer, television, cd player $1000),

(television, music system, console, $600),
(cd player, console, music system $400))
Bundle bidding scenario

((Computer, television, cd player $1000),

(television, music system, console, $600),
(cd player, console, music system $400))
Bundle bidding scenario

((Computer, television, cd player $1000),

(television, music system, console, $600),
(cd player, console, music system $400))
Multiple-item auctions

• Auction of multiple, distinguishable items

• Bidders have preferences over item
combinations
• Combinatorial auctions
– Bids can be submitted over item bundles
– Winner selection: combinatorial optimization
• NP-complete
Source
• Vijay Krishna: Auction Theory (Academic Press)
• Paul Klemperer: Auction Theory: A guide to the
literature (Journal of Economics Survey)
• Elmar Wolfstetter: Auctions An Introduction
• Tuomas Sandholm COURSE: CS 15-892
Foundations of Electronic Marketplaces (CMU)