THE ROLE OF THE BIDDING PROCESS IN PRICE DETERMINATION: JUMP BIDDING IN SEQUENTIAL ENGLISH AUCTIONS

I. INTRODUCTION Standard auction theory predicts that in a private-value English oral auction, the winner will be the bidder with the highest valuation for the object and the selling price will be the second-highest valuation. In those auctions, a reasonable strategy for a bidder would be to increase each bid by the minimum bid increment. This solution is referred to as the "ratchet solution," "straightforward bidding," or as "pedestrian bidding." Jump bidding occurs when a new offer is submitted that is above the old offer plus the minimum bid increment permitted. In this paper, I study the sequence of bidding in an open-outcry English auction to examine how strategic bidding affects price determination. I do this by examining the nature of jump bidding in data I have collected from a series of public auctions of used cars in New Jersey. The auction literature has not fully addressed and characterized jump bidding in English auctions. The theoretical literature on the conditions under which jump bidding will emerge (e.g., Avery 1998; Daniel and Hirshleifer 1998; Easley and Tenorio 2004; Isaac, Salmon, and Zillante 2007; Macskasi 2000; Rothkopf and Harstad 1994) does not include any models of English auctions with affiliated values and discrete bid levels. Table 1 summarizes the different models' predictions. The empirical and experimental literature on jump bidding is also quite narrow. Plott and Salmon (2004), Isaac, Salmon, and Zillante (2005, 2007), and Isaac and Schnier (2005) found support for jump bidding in their studies. Borgers and Dustmann (2005), in analyzing the United Kingdom's sale of licenses for third-generation mobile telephone services, found that, although the majority of bids in the auction were the lowest admissible bids, there were a significant number of jump bids. Haile and Tamer (2003) also documented jump bidding in a regular English auction and reported that the gap between first-and second-highest bids is usually above the minimum bid increment allowed. Section II provides a detailed literature survey. In order to characterize jump bidding, and because the auctions I study have no seller's reserve price, I define the "First Jump" as the first offer submitted by any bidder. The "Second Jump" is the difference between the second offer submitted by a bidder and the first offer. The "Last Jump" is the difference between the winning bid and the previous offer. (1) I further define the "Average Jump" (2) across all jumps excluding the First and Last Jumps. Figure 1 describes these variables graphically. I find that jump bidding is a widespread empirical regularity in the sale of all items. The jumps depend on the presale estimate of the item's price and are not affected by the selling order. For almost all items, bidders use jump bidding to increase the current offer. Furthermore, on average, the First Jump is greater than the Second Jump, which is greater than the Average Jump, which in turn is greater than the Last Jump. I offer several explanations for the existence of jump bidding. These findings suggest that there is some strategic bidding behavior in the way bidders advance their bids. Bidders consider the way the auction progresses, which implies that a bidder's strategy includes not only the stopping point along the bidding path but also the precise nature of the path that led there. Consideration of jump bidding strategy sheds light on whether an open-outcry auction is best interpreted with models that assume private- or common-item valuations. Under the assumption of independent private values, bidding history should not affect the point at which a bidder drops out. This is not the case in a common-value auction, in which each stage of the auction is used as a device for signaling. The selling price in an English auction with common values will be path dependent. Hence, a simple test of the effect of the First Jump on the selling price determines the type of the auction. …