How English auction maximizes profits in art auctions
ART AUCTIONS: How the English auction maximize s profits in art auctions Rosanne Hui Market Design & Auction Theories Presentation 12/01/2010 The English Auction Ascending bids Strategically similar to Vickrey auction, in which the winner pays the seco nd-highest bid price. But bids are public, not sealed.
Procedure: 1. Auctioneer calls out the suggested opening bid 2. Bidders make open bids and the auctioneer accepts bids - Highest bidder at any given moment holds the standing bid. - Only a higher bid accepted by the auctioneer can replace the standing bid and become the new standing bid. 3. When there is no new bid within a period of time: Auctioneer will hamm er down. SOLD. - Item is said to be hammered down or knocked down. - The price is called hammer price. Price starts low and increases as bids are made. Art as the auctioned good
Characteristics: uniqueness Unique only one of its kind is available in the entire m arket. Heteogeneous. Valued differently by different groups & individuals: A. Scholars, Art Historians & Collectors who know and w ant the piece for research B. Investors who see art pieces as investment goods (hed ge funds) / a way to store capital C. Individual who merely wants the good for personal like s/dcoration. Why art auction? Art is therefore unlike other multiple identical goods (e.g. land, car
plateetc.) Art is more individualized, one original copy by one artist Example: Person A, who is an artist himself, is very attached to pain ting x because his art teacher valued x for its high quality and it was the only thing he carred with him while he ran away during a war. Each piece of art suits different tastes Example: For person A, art x > art y > art z For person B, art z > art x > art y Hence each individual values a piece of art differently NO common value for a piece of artwork Why art auction?
How art is valued Scale (size, level of details) Intensity & quality (effort, skills) Medium (gold involved? Or just wood?) Quality of preservation Historical value Rarity (How many paintings of the same subject are done by the same artist?) Real or fake Artist (Known or unknown? Higher level of risk if unknown) Value to oneself and to the others - A piece of art might be more valuable to a collector if it is the last piece that he needs to make his collection of an artists work complete - An investor might think: how others appreciate the piece of art?)
Market demand in the future (involves liquidity capability) Why art auction? However, these values cannot be given a speci fic value that everyone agrees on. [each piece of art has a distinctive utility level for each indi vidual] Exchange of information on the value of th e artwork is important to buyers, sellers and a uctioneers. Auction Houses Christies worlds largest auction house (1766)
Sothebys worlds 2nd largest auction house (1744) Phillips de Pury & Company - 1796 How the art auction functions Employs the English auction Before the auction takes place: Appraisals* Catalogues; Pre-auction viewing Experts opinions, past sales history, predicted market p erformance Estimations (Lower estimate, Higher estimate) Hammer price tends to be close to the average of the lo wer estimate and the higher estimate
Seller sets reserve price that is not revealed* Buyer registers; gets a paddle During the auction: Auctioneer starts by announcing the Suggeste d Opening Price Bids constantly replace the standing bid Auction ends when there is no higher bid after a certain period of time. Identity of bidder not necessarily revealed: flo or bid; telephone bid; online bid; absentee bid After the auction:
Buyer pays price of second-highest bid + premium price to auctione er. - Buyers Premium = Percentage (%) the buyer pays in addition to t he final bid price or hammer price in respect of each Lot purchased (Christies) - ranges from 10-25% depending on location of auction Seller receives money and pays commission to auctioneer. 10-25% Possibility of resale : at another auction or privately -Droit de Suite: a royalty payable to a qualifying artist or the artist 's heirs each time a work is re-sold during the artist's lifetime and d uring the 70 years following the artist's death. Art Auction
Characteristics Few wealthy individuals/institutions enter the market to plac e bids Information on how much others will pay for an art piece is cr ucial to maximizing profits for an auction house Such information is gathered by: 1. Repeated sales records (number of repeated sales + hamm ered prices) 2. Observed hedonistic characteristics + unobserved informati on of the artwork before auction 3. On-the-spot information exchange as bidders bid (provide d by English auction) which reflects current market deman d
The Auctioneers Goal Despite the vagueness and complexities of pricing art, the auctioneer aims to: Maximize profits, realize full economic value of the product sold How? Some points to consider Increase number of participants Promote competition within pool of participants Maximize the sum of the valuations of the art b eing sold Strengths of the English auction
*Price-Discovery Mechanism: process of determining the price of the goo d during interactions amongst players in a market, i.e. sellers and buyers Facilitated by the English auction as bids are transparent and made publi c on the auction floor. Creates new floor as price reference as bids go up - After seeing how many other bidders are interested in a particular art work and how much they are willing to pay, bidder re-evaluates the artw ork and bid accordingly Only allowed by English auction because of its transparency and its allo wing room for reevaluation while the bidding occurs. As oppose to the al ternatives, e.g. Dutch auction (sealed, the bidding is over as long as som eone places the bid)
Strengths of the English auction Reduces winners curse Winners curse: Winner loses money because he pays a price over the actual value In an English auction, bidder can observe how mu ch the other bidders value the good. Winners cur se reduced: even when he wins a good for a price over the actual value, he knows how much the se cond bidder is willing to pay for it. This loss is the n restricted. Strengths of the English auction Reduces winners curse
Reduces potential bidders uncertainty & risks Also, in the English auction, only the winner will pay Increases Bidders confidence Increases number of bidders in the auction, who are con fident to bid more - Initially ignorant potential bidders quickly gain inform ation on the spot and are prompted to participate - Bidders already bidding see competition, reflects mar ket value, bids higher Bidders truthfully reveal price, hence Walrasian equilibrium will be reached. Inefficiency reduced since more information re
vealed, shows bidders degree of preference f or an artwork More on why information is essential to maxi mizing profit in art auction Brief comparison with timber auction (Susan Athey & Jonathan Levin 1999)
also requires speculation Later bids are more informed reflect more accurate bid estimates gets information from other bidders bids winning bidders are effectively paying a lower p ercentage of their bids than lower-ranked bidder s Limitations of English auctions in art auctions 1. Major bidders are limited to a few wealthy individuals/instit utions who are interested in investing in art + have the financ ial capacity to do so
They will dominate the market because even if they are u ninformed, other competing bidders will inform them of the value of the artwork on the spot. The wealthiest ones will al ways win. Good for the auction house in the short run but discourag es others from bidding. Hence reduce no. of participating bidders further Decrease in information exchange Limitations of English auctions in art auctions 2. Needs to set lower and higher estimates, but difficult and cos tly to obtain information to make the estimations. Hence usu
ally biased. - Oftentimes sellers bring forgeries for sale either intentionally or unknowingly - Costly to employ specialists, connoisseurs to authenticate the art, but important to do so in order to keep up the reputation of the auction house - Also takes time to authenticate art, at the same time public ta stes may change (esp. for unknown artists) - Even when the art is real, complicated to set a value to it - Many attempts to analyze the pricing methods Limitations of English auctions in art auctions Empirical Model for sale price of artwork
Value of an art (Alan Beggs and Kathryn Graddy 2009) t = X + + t X = characteristics of the art t = timing effect = how much the individual values each unit increase of X Sale price or Presale estimate PR = + (PP-1- ) + (PP-1- -1) = 1 if the art is sold at previous sale; = 0 if unsold at previous sale P-1 = price at previous sale = 1 if the art is sold at previous sale; = 0 if unsold at previous sale
-1 = extra information i.e. components to quality not captured by the observabl e characteristics but that are observed either by auctioneer, buyers, sellers, o r which the participants use past prices to learn about Limitations of English auction in art auctions However, X (the characteristics of the artwork) in itself is hard to measure Example: Cannot measure value by level of det ails Kasimir Malevich, Suprematist Composition (blue rectangle over the red beam), 1916, sold for $60 million at a Sothebys auction
in 2008. Limitations of English auction in art auctions English auction provides for the information in terms of how other inte rested bidders are willing to pay for the artwork. However this information is still not sufficient in accurately valuing an d pricing the artwork, which then affects the valuation by bidders duri ng the auction. While it is tempting to overprice an item, it is also possible to underval ue it without knowing loss. i. Chanel, et. al. (1996): Most auction houses undervalue most types o f jewelry, with the exception of some watches
ii. Beggs and Graddy (1997) : Art: Recently executed works tend to be overvalued; longer and wider paintings are undervalued. iii. Bauwens and Ginsburgh (2000): English silver: Christie's systematic ally underestimates; Sotheby's overvalues inexpensive pieces and und ervalues expensive pieces Further Work Comparison to other types of auctions where speculation is required Empirical data on how the revelation of price during English auction encourages higher bids from bidders / how bidders influence each oth er and increase the hammer price
Sources Orley Ashenfelter & Kathryn Graddy, Art Auctions, CEPS Working Paper No. 203, Princeton University & Oxford University, March 2010. Alan Beggs and Kathryn Graddy, Anchoring Effects: Evidence from Art Auctions, American Economic Review 2009, 99:3, 10271039 Orley Ashenfelter & Kathryn Graddy, Art auctions: A survey of empirical studies, National Bureau of Economics Research Working Paper 8997, 2002. Wilbur C. Whitehead, Auction Bridge Standards, NY: Frederick A.Stokes Company Publishe rs, 1921 Faruk Gul & Ennio Stacchetti, The English Auction with Differentiated Commodities, Prince ton University & University of Michigan, 1999 Lawrence M. Ausubel, On Generalizing the English Auction, Department of Economics, Uni
versity of Maryland, 1997 Susan Athey & Jonathan Levin, Information and Competition in U.S. Forest Service Timber Auctions, NBER Working Paper 7185, 1999 Paul Klemperer, Auctions: Theory and Practice, Princeton University Press, 2004 Mayukh Dass & Srinivas K. Reddy, Bidder Behavior and Bidder Networks in Online Auction s, Texas Tech University, 2010
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