Fantasy Of The Optimal Auction: Vickrey Auction
Vickrey Auction, also called Second Price Sealed-bid, is a special type of auction, in which the highest bidder wins and he or she pays the second highest price. Some people call it the most honest auction because, in theory, it is always the best choice for bidders to be truthful of what they think of an object. Let’s say, V is what you value for an object, which is $100 in this case and B is the amount of money you actually bid in. If you bid B less than $100 and win the auction, it’s good. In a different situation, you bid $90 and other bidders bid $95. You lose an auction and do not get an object you want. However, you could have won the auction if you have bid $100, which you thought a true value for an object. What if you bid B more than $100 and other bidders also bid more than $100, but less than B? You win an auction, but you pay more than what you value for an object. You do not want to win in this case. Therefore, in any cases, to bid what you value for an object is always the best choice to yourself.
As explained above, Vickrey auction seems to have a truthful winning system. Why not using it for all auctions then? In reality, however, it is rarely used because “Cheatings” can easily manipulate the auction.
Vickrey Auction is vulnerable to shill bidding. Let’s say a bidder has two accounts. He uses one to bid high so he can have a secured winning position. He uses the other to bid low to minimize the price he would pay for an object if he wins. More vulnerable situation is when auctioneers cheat by a fake bid. For example, you bid an object for $1,000 and the second highest price for the bid is $600. You are very happy to buy an object at such a cheap price because you think the true value for the object is $1,000. However, you do not know the second highest bid is $600 until the auction ends and auctioneers tell you that you are a winner. Here the “Cheaters” play.
Auctioneers always want to sell their objects at higher price to earn more money through auctions. In this case, they know that there is a huge difference between your bid and the second highest bid. Although $600 might exceed the original value for the object, they are not satisfied with it because they know they can earn money close to $1,000 by cheating; they make a fake bid of $950. Now, they announce to every bidder that you win the object for $950. Nobody knows $950 is from a fake bid because every bidder’s price is sealed. You would be still happy because you buy the object cheaper than what you value. However, you can buy it way cheaper than $950 and you do not know the truth unless auctioneers suddenly become honest and tell you that they have cheated, which would not actually happen.
As we learned in lectures, Vickrey auction has such a good theory, which is believed to lead people to join auctions with honesty. However, the theory has not worked well in reality. Not only Vickrey auction is vulnerable to “Cheatings”, but also are other types of auctions. There is no such an optimal auction. Therefore, we should be more careful in joining an auction and aware that there is always some probability that we can be the victims of “Cheatings.”
Resource : http://www.beyonddiscovery.org/contetn/view/page/asp?I=3685
A web article that explains a theory of Vickrey auction and its future directions