Aversion to price risk and the afternoon effect

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Mezzetti, Claudio (2008)
  • Publisher: University of Warwick, Department of Economics
  • Subject: HB
    acm: TheoryofComputation_GENERAL | TheoryofComputation_MISCELLANEOUS

Many empirical studies of auctions show that prices of identical goods sold sequentially follow a declining path. Declining prices have been viewed as an anomaly, because the theoretical models of auctions predict that the price sequence should either be a martingale (with independent signals and no\ud informational externalities), or a submartingale (with affiliated signals). This paper shows that declining prices, the afternoon effect, arise naturally when bidders are averse to price risk. A bidder is averse to price risk if he prefers to win an object at a certain price, rather than at a random price with the same expected value. When bidders have independent signals and there are no informational externalities, only the effect of aversion to price risk is present and the price sequence is a supermartingale. When there are informational externalities, even with independent signals, there is a countervailing, informational effect, which pushes prices to raise along the path of a sequential auction. This may help explaining the more complex price paths we observe in some auctions.
  • References (6)

    [19] Ginsburgh, V. and J. Van Ours (2007): How to Organize a Sequential Auction. Results of a Natural Experiment by Christie’s. Oxford Economic Papers, 59 (2007), 1-15.

    [20] Jeitschko, T. (1999): Equilibrium Price Paths in Sequential Auctions with Stochastic Supply. Economics Letters, 64, 67-72.

    [21] Jeitschko, T. and E. Wolfstetter (1998): Scale Economies and the Dynamics of Recurring Auctions. Economic Inquiry, 40, 403–414.

    [22] Jones, C., F. Menezes and F. Vella (2004): Auction Price Anomalies: Evidence from Wool Auctions in Australia. Economic Record, 80 (250), 271-288.

    [23] Katzman, B. (1999): A Two Stage Sequential Auction with Multi-Unit Demands. Journal of Economic Theory, 86, 77-99.

    [25] Krishna, V. (2002): Auction Theory, San Diego, California: Academic Press.

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