The Sealed-Bid Abstraction in Online Auctions

Abstract:     
This paper presents five empirical tests of the popular modeling abstraction that asserts bids from online auctions with proxy bidding can be analyzed "as if" they were bids from a second-price sealed-bid auction. The tests rely on observations of the magnitudes and timings of top two proxy bids, with the different tests stemming from different regularity assumptions about the underlying distribution of signals. We apply the tests to data from three eBay markets - MP3 players, DVDs, and used cars - and we reject the sealed-bid abstraction in all three datasets. This consistent rejection casts doubt on several existing theories of online-auction behavior and suggests that some demand estimates based on the abstraction can be biased. To assess the magnitude of the bias, we propose and estimate a new model of bidding behavior. The model assumes that although some bidders conform to the sealed-bid abstraction, other bidders bid in a reactive fashion. Since reactive bidding can be at least partially detected from the data, it is possible to estimate the underlying distribution of demand and compare it to what the sealed-bid abstraction implies. We find that relative to our proposed model, assuming the sealed-bid abstraction results in a large downward bias in demand estimates and the reserve prices the seller should charge.

Keywords: eBay, empirical auctions, sealed bidding, online auction

JEL Classifications: D44

Working Paper Series