Auctions, Market Prices and the Risk Attitude
Tinbergen Institute Discussion Paper No. 2005-025/1
28 Pages Posted: 26 Nov 2005
Date Written: February 2005
This paper develops one possible argument why auctioning licenses to operate in an aftermarket may lead to higher prices in the aftermarket compared to a more random allocation mechanism. Key ingredients in the argument are differences in firms' risk attitudes and the fact that future market profits are uncertain so that winning an auction is like winning a lottery ticket. If one license is auctioned, auctions select the firm that is least risk averse. This is what we call the risk attitude effect. Firms that are less risk averse tend to set higher prices (or higher quantities in case quantity is the decision variable) in the marketplace than an average firm. When multiple licenses are auctioned, this conclusion gets strengthened when there is a differentiated Bertrand oligopoly in the marketplace. In case of Cournot competition, a strategic effect works against the risk attitude effect so that under certain conditions the more risk averse firms will be selected leading (again) to higher market prices.
Keywords: Auctions, Risk Attitude, Aftermarkets
JEL Classification: D43, D44, D82
Suggested Citation: Suggested Citation