Countering the Winner’s Curse: Optimal Auction Design in a Common Value Model

Abstract

We characterize revenue maximizing mechanisms in a common value environment where the value of the object is equal to the highest of bidders’ independent signals. The optimal mechanism exhibits either neutral selection, wherein the object is randomly allocated at a price that all bidders are willing to pay, or advantageous selection, wherein the object is allocated with higher probability to bidders with lower signals. If neutral selection is optimal, then the object is sold with probability one by a deterministic posted price. If advantageous selection is optimal, the object is sold with probability less than one at a random price. By contrast, standard auctions that allocate to the bidder with the highest signal (e.g., the first-price, second-price or English auctions) deliver lower revenue because of the adverse selection generated by the allocation rule: if a bidder wins the good, then he revises his expectation of its value downward. We further show that the posted price mechanism is optimal among those mechanisms that always allocate the good. A sufficient condition for the posted price to be optimal among all mechanisms is that there is at least one potential bidder who is omitted from the auction. Our qualitative results extend to more general common value environments where adverse selection is high.