Auction
An
auction is the
process of
buying and selling things by offering them up for bid, taking bids, and then selling the item to the highest bidder. In economic theory an auction is a method for determining the value of a commodity that has an undetermined or variable price. In some cases, there is a minimum or
reserve price; if the bidding does not reach the minimum, there is no sale (but the person who puts the item up for auction still owes a fee to the auctioneer). In the context of auctions, a bid is an offered price.
Auctions are publicly seen in several contexts: in the antique, where besides being an opportunity for trade they also serve as social occasions and entertainment; in the sale of collectibles such as stamps, coins, classic cars, and fine art; in thoroughbred horseracing, where yearling horses are commonly auctioned off; and in legal contexts where forced auctions occur, as when one's farm or house is sold at auction on the courthouse steps.
Much more economically important, however, are auctions in which the bidders are businesses or corporations. Examples of this type of auction include:
- spectrum auctions, in which companies purchase licenses to use portions of the electromagnetic spectrum for communications (for cell phone networks, for example.)
- timber auctions, in which companies purchase licenses to log on government land.
- electricity auctions, in which large-scale generators and consumers of electricity bid on generating contracts.
- procurement auctions, in which companies submit bids on a government contract. In this situation the auction is reversed and the winner will be the company that submits the lowest bid to perform the work.
Internet auctions, dominated by the wildly successful
eBay, have become very popular.
The world two largest auction houses are Christie's and Sotheby's. The world's largest online auction site is EBay.
Auction catalogs are frequently printed and distributed before auctions of rare and/or collectible items; these catalogs may be very elaborate works, with considerable details about the items being auctioned.
Types of Auctions
Some commonly used types of auctions are:
- English auction: In this type of auction participants bid openly against one another, with each bid being higher than the previous bid. The auction ends when no participant is willing to bid further, or when a pre-determined "buy-out" price is reached, at which point the highest bidder pays the price.
- Dutch auction: In the traditional dutch auction the auctioneer begins with a high asking price which is lowered until some participant is willing to accept the auctioneer's price. That participant pays the last announced price. This term can also be used to describe online auctions where several identical goods are sold simultaneously to an equal number of high bidders.
- Sealed first-price auction: In this type of auction all bidders simultaneously submit bids in such a way that no bidder knows the bid of any other participant. The highest bidder pays the price he submitted.
- Sealed second-price auction, also known as a Vickrey auction: This is identical to the sealed first-price auction, except the winning bidder pays the second highest bid rather than his own. Both the English and the second-price sealed-bid auctions will theoretically lead to the bidder's bidding up to (or submitting as a sealed bid) their true valuation of the item. These two auctions are theoretically equivalent, a result which has been verified in practice as well.
If more than one identical item is sold, there are two possible generalizations of the second-price auction. In a uniform-price auction, all of the winning bidders pay the price submitted by the highest non-winning bidder. Bidders will not typically bid their true value in a uniform-price auction with multiple units. In a Vickrey auction, the pricing rule is more complicated, but preserves the property that bidders will bid their true valuation.
Bidders in the traditional Dutch auction and sealed first-price auction will tend to underbid what they believe the item is truly worth in hopes of getting the item for less. This behavior is known as bid shading. These two auctions are also theoretically equivalent, but in practice Dutch auctions will produce less revenue than sealed first-price auctions (one of the important results of Experimental economics)
Work in the theory of auctions contributed to Vickrey's 1996 Nobel Prize in Economics
See Also
Auction catalog
An
auction catalog is a
catalog that lists items to be sold at an
auction. Auction catalogs for rare and expensive items, such as
art,
jewelry,
postage stamps, and antique furniture, are of interest in and of themselves, for they will frequently include detailed descriptions of the items, their
provenance, historical significance, photographs, and so forth. In some cases, auction catalogs are key documentation for rare objects that are in private collections, and make up an important part of the libraries of students and dealers of the rarities.
Each entry typically includes a "lot number" identifying each item uniquely, a detailed textual description, and either an estimated price, or a "reserve" price below which the item will not be sold. Photographs may appear with the entry, or grouped into a separate section of the catalog; for mass-produced items like postage stamps, the textual description may be considered sufficient.
As a combined information source and "sales brochure", an auction catalog must tread a fine line between accuracy and promotion. For instance, any damages or flaws must be described exactly, so that buyers cannot be claim to have been deceived, but at the same time the description will typically include words playing down the bad points (as in "brownish spot that does not detract from appearance" or "faint crease, as is common"). Similarly, special characteristics are also called out, such as "one of only four known examples of this type", or perhaps a photograph of an item of jewelry being worn by a famous person.
Auction catalogs may be sent gratis to favored customers, but the better catalogs will cost, sometimes as much or more than a regular book. These kinds of catalogs may in turn be sold by bookstores, or even appear as items in book auctions.
Some time after the auction is concluded, recipients of the auction catalogs will receive a "prices realized" document, a bare listing of the lot numbers and the prices for which each was sold.
Arbitrage
In
economics,
arbitrage is the practice of taking advantage of a state of imbalance between two (or possibly more)
markets: a combination of matching deals are struck that exploit the imbalance, the profit being the difference between the market prices. A person who engages in arbitrage is called an
arbitrageur.
For example, if you can buy items at one price at a factory outlet and sell them for a higher price on an internet auction website such as eBay, you can exploit the imbalance between those two markets for those items. The term "arbitrage", however, is usually applied only to trading in money and investment instruments (such as stocks, bonds, and other securities), not to goods, and the difference in prices is usually referred to as "the spread", so arbitrage is often defined as "playing the spread" in the money market.
Arbitrage has the effect of causing prices in different markets to converge. As a result of arbitrage, the currency exchange rates, the price of commodities, and the price of securities in different markets all tend to converge to a fixed price. The speed at which the prices converge is one measure of the efficiency of a market.
Examples
Here's a theoretical example: Suppose that the exchange rates (after taking out the fees for making the exchange) in London are £5 = $10 = ¥1000 and the exchange rates in Tokyo are ¥1000 = £6 = $10. Converting $10 to £6 in Tokyo and converting that £6 into $12 in London, for a profit of $2, would be arbitrage.
One real-life example of arbitrage involves the stock market in New York and the futures market in Chicago. When the price of a stock in New York and its corresponding future in Chicago are out of sync, one can buy the less expensive one and sell the more expensive. Because the differences between the prices are likely to be small (and not to last very long), this can only be done profitably with computers examining a large number of prices and automatically exercising a trade when the prices are far enough out of balance. The activity of other arbitrageurs can make this risky. Those with the fastest computers and the smartest mathematicians take advantage of series of small differentials that would not be profitable if taken individually.
Risks
Arbitrage is subject to a number of risks which become magnified when leverage or borrowed money is used. It can be problematic if prices shift adversely during the execution of trades. Another risk occurs if the items being bought and sold are not identical and the arbitrage is conducted under the assumption that the prices of the items are correlated or predictable.
Long-Term Capital Management (LTCM) lost $100 billion mis-managing this concept in September 1998. LTCM had attempted to make money on the difference between different bond instruments. For example, it would buy U.S treasury bonds and sell Italian bond futures. The concept was that because Italian bond futures had a less liquid market, in the short term Italian bond futures would have a higher return than U.S. bonds, but in the long term, the prices would converge. Because the difference was small, large amount of money had to be borrowed to make the buying and selling profitable.
The downfall in this system began on August 17, 1998, when Russia defaulted on its rouble debt and domestic dollar debt. Since the markets were already nervous due to the Asian crisis, investors began selling non-U.S. treasury debt and buying U.S. treasuries, which were considered a safe investment. As a result the return on U.S. treasuries began decreasing because there were many buyers, and the return on other bonds began to increase because there were many sellers. This caused the difference between the returns of U.S. treasuries and other bonds to increase, rather than to decrease as LTCM was expecting. Eventually this caused LTCM to fold, and a bailout had to be arranged to prevent a collapse in confidence in the economic system.
An ironic footnote is that they were right long-term (the LT in LTCM), and a few months after they folded their portfolio became very profitable. However the long-term does not matter if you cannot survive the short-term, and that they failed to do.
