Auctions of Real Options
54 Pages Posted: 26 Aug 2012 Last revised: 6 Feb 2018
Date Written: January 26, 2018
Governments and corporations frequently auction assets with embedded real options using both cash and contingent bids. I characterize equilibrium bidding and option exercise strategies, and find that the moral hazard associated with the uncontractible investment timing inefficiently and asymmetrically accelerates or delays investments. I use a mechanism design approach instead of security "steepness" to rank securities and derive the optimal security. Furthermore, without sellers' commitment to the security design, all auction equilibria are equivalent to cash auctions, and investments are socially efficient. The results are broadly consistent with empirical observations, for example in the sales of oil leases.
Keywords: Real Options; Auctions; Acquisitions; Security Design; Timing Games; Oil and Gas Leases
JEL Classification: D44, D81, D82, G13, G31, G32, L24
Suggested Citation: Suggested Citation