Why aren’t homes sold in Second Price Auctions?
Second price, sealed-bid auctions (Vickrey auctions) happen to be the most common auctions there are. Sites like e-bay use this strategy in deciding the price at which goods are sold to on average optimize payoffs to both sellers and buyers. But are these auctions applied in areas where it seems perfectly reasonable to use them, say in real estate? In a blog post, chairman Emeritus of Electronic Frontier Fund Brad Templeton shares his thoughts on why second-price auctions are not used in the sale of homes, and I summarize his ideas below.
According to Brad, the driving force behind irrational behavior in home buyers is that a huge proportion of the public does not understand how second-price auctions work. Sellers, knowing this, can therefore take advantage of buyers by prompting them to bid higher than the value of the real estate in question, driving up the seller’s profitability. One of the main reasons is because home purchase for example happens rarely in individual’s lifetimes—perhaps once or twice and they thus strive to purchase the home at whatever cost without necessarily considering their true value of the asset; all they want is to win. As such, the public tends to misunderstand second-price auctions the mechanisms behind it. Particularly, they do not appreciate the importance of figuring out one’s true value of the asset and being happy with the result of the auction whether or not they win. However, this is a matter of contention as people’s perception of ‘loss’ for an asset sold at say $1.002 million when their bid was $1 million may be different from that of an e-bay item sold for $30 when their bid was $25.
The question though remains, would a second-price auction be optimal? As we discussed in class multiple times, yes—incumbent upon the auction being a second price, sealed-bid auction. The dominant strategy in a second price sealed bid auction is always bidding one’s true value of an item. In this case, if one’s bid is the highest, they win the asset and pay the second highest bid. On the other hand, if they do not win, then it is solely because their payoff would otherwise be at-least zero, in which case one should be indifferent. The outcome therefore is dependent on whether or not buyers know what their actual value of the asset is. Unfortunately, in the case of very expensive assets, this does not seem to be the case!
https://ideas.4brad.com/why-arent-homes-sold-second-price-auctions