Least-Present-Value-Of-Revenue Auctions and Highway Franchising

Posted: 21 Feb 2002

See all articles by Eduardo M. R. A. Engel

Eduardo M. R. A. Engel

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Alexander Galetovic

Universidad Adolfo Ibáñez; Stanford University - The Hoover Institution on War, Revolution and Peace; University of Padua - CRIEP

Ronald D. Fischer

University of Chile - Center of Applied Economics (CEA)

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Abstract

In this paper we show that fixed-term contracts, which are commonly used to franchise highways, do not allocate demand risk optimally. We characterize the optimal risk-sharing contract and show that it can be implemented with a fairly straightforward mechanism--a least-present-value-of-revenue auction. Instead of bidding on tolls (or franchise lengths), as in the case of fixed-term franchises, in an LPVR auction the bidding variable is the present values of toll revenues. The lowest bid wins and the franchise ends when that amount has been collected. We also show that the welfare gains that can be attained by replacing fixed-term auctions with LVPR auctions are substantial.

Keywords: Fixed-term contracts, highway franchising, demand risk

JEL Classification: D81, H42

Suggested Citation

Engel, Eduardo M. and Galetovic, Alexander and Fischer, Ronald D., Least-Present-Value-Of-Revenue Auctions and Highway Franchising. Journal of Political Economy, Vol. 109, October 2001. Available at SSRN: https://ssrn.com/abstract=280270

Eduardo M. Engel (Contact Author)

Yale University - Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States
203-432-5595 (Phone)
203-432-5779 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alexander Galetovic

Universidad Adolfo Ibáñez ( email )

Peñalolén
Santiago
Chile

Stanford University - The Hoover Institution on War, Revolution and Peace ( email )

Stanford, CA 94305-6010
United States

University of Padua - CRIEP ( email )

Padua
Italy

Ronald D. Fischer

University of Chile - Center of Applied Economics (CEA) ( email )

Republica 701
Casilla 2777
Santiago
Chile
+56/2/678 4055 (Phone)
+56/2/689 7895 (Fax)

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