Standard Auctions with Security Bids

Abstract

Peter DeMarzo, Ilan Kremer and Andrzej Skrzypacz (2005) study auctions where bidders compete in securities. As the main results, they show that: a steeper security generates a higher revenue for the seller; the revenue ranking between the first-price and second-price auction depends on the steepness of security; and the first-price auction combined with call option achieves the highest revenue among a general set of auction mechanisms. As pointed out by Che and Kim (2010), using steeper securities can cause the adverse selection problem and reduce the seller’s revenue, in case a bidder who expects a higher return must incur a higher investment cost. While the analysis of Che and Kim (2010) focuses on the second-price auction, this paper analyzes the first-price auction to show that it is plagued by the same problem and in fact more vulnerable than the second-price auction to the adverse selection problem, which may lead to a reversal of the DKS’s revenue ranking between the two auctions.