Bidding Strategies in Internet Yankee Auctions

Abstract

A bidding strategy commonly observed in Internet auctions, though not frequently in live auctions, is that of "jump-bidding," or entering a bid larger than necessary to be a current high bidder. In this paper, we argue that the cost associated with entering on-line bids and the uncertainty concerning bidding competition -- both of which distinguish Internet from live auctions -- can explain this phenomenon. We present a simple theoretical model that accounts for the preceding characteristics, and derive the conditions under which jump-bidding constitutes an equilibrium strategy in a format commonly used for on-line trading, the Yankee Auction. We then present evidence recorded from hundreds of Internet auctions that is consistent with the basic predictions from our model. We find that jump-bidding is more likely earlier in an Internet auction, when jumping has a larger strategic value, and that the incentives to jump bid increase as bidder competition becomes stronger. Several of our results have implications for starting bid and minimum bid increment rules set by Internet auction houses. We also discuss possible means of reducing bidding costs, and evidence that Internet auctioneers are pursuing this goal.

JEL Classification: D44