The 2020 Nobel Prize in Economics went to Robert Wilson and Paul Milgrom to contribute to Auction Theory. So what was their contribution, and why did they win the Nobel Prize? We’ve all heard stories about how the government auctions resources such as Telecom Spectrums or even oil reserves.
But these auctions can sometimes be complicated. Take, for instance, the year 1997. Venezuela is auctioning an Oil Reserve. This Auction is not like how you and I imagine auctions to be where everybody is screaming bids, and finally, a hammer falls, and an item is declared as sold. The bidders submit their requests in a closed envelope of sorts. No one knows how much the other parties who are also participating in the Auction are bidding.
Each bid is based on how each bidder has estimated the value of the item being auctioned. Now, this can be a bit tricky. Sometimes you could overestimate the importance. At the same time, sometimes, you could also underestimate the value.
In this particular example – A Chinese Corporation was the highest bidder, and it turned out that they had overestimated the cost. There’s a term for this, and it’s called the winner’s curse, where you end up overpaying because you have overestimated the value of the item being auctioned.
How does one avoid the Winner’s Curse?
Milgrom and Wilson proposed that if bidders had more insight into the article’s value, such as authenticity certificates, expert appraisals, and most importantly, insight into other people’s bids, bidders could avoid the Winners Curse.
In this example, if this Chinese corporation had known the recommendations of the other people participating in this Auction, they would have immediately known that they had overestimated the value and could have adjusted the bid accordingly.
The second problem that Wilson and Milgrom addressed has to do with multiple items being auctioned. Traditionally would auction various things one after the other. Take, for instance, the Spectrum Auction in Switzerland in the year 2000. The government of Switzerland wanted to auction 3 Frequency Blocks.
If you had the license for one frequency block, you could transmit across Switzerland. When was put up the first block for Auction, it went for 121 million. When putting up the second bock for Auction, it went for 134 million. Now when putting up the third bock for Auction, things got a little bit interesting. Because the third block was the biggest, it was twice the size of the first two blocks. It is technically the most valuable block and should have gone for a higher amount than 121 million and 134 million. But when it finally went up for Auction, it only went for 55 Million.
How did the most valuable block go for such a low amount?
The bidder who bought the first two blocks had spent so much money in the first two blocks that they could not participate in the third block’s Auction. This happens when items are sold one after the other. So what Milgrom and Wilson did was that they proposed a new auction method where multiple items could be auctioned simultaneously. This unique auction method is called Simultaneous Multiple Round Auction, or SMRA.
Imagine if auctioned all three bands simultaneously, then the bidders would no longer have to worry about spending a lot of money on one band, only to realize later that they don’t have money for other bands. So, in this case, with SMRAs, since all bands are put up for Auction simultaneously, bidders can bid for multiple rounds at the same time, and both bidders and governments can enjoy much better outcomes. And for these contributions to Auction Theory, Robert Wilson and Paul Milgrom were awarded the Nobel Prize in Economics.