The role of varying risk attitudes in an auction with a buyout option (Q818534)

The authors analyze a second price auction with a buyout option. A buyout option allows a bidder to purchase the item being auctioned at a pre-specified buyout price, instead of attempting to obtain the item through the traditional auction procedure. Such options are available in the internet auctions. The model presented in the paper considers a situation in which bidders with independent private valuation drawn from a common continuous distribution attempt to acquire a single object. The central problem is the impact of varying attitudes toward risk by a seller facing risk neutral bidders. The results are as follows. A risk neutral seller will choose a buyout price high enough so that an option is never exercised, whereas the risk averse seller choice will be the price low enough so that the option is exercised with positive probability. Under the assumptions that a seller is risk averse, bidders are risk neutral and their valuations are drawn from a convex distribution function, the authors prove that allowing the seller to offer a buyout option results in a Pareto improvement, in comparison to a sealed bid second price auction.