Auction market is a type of trade where at the same time buyers enter bids and sellers enter offers. The trade price is the highest price that buyer is willing to pay, and the lowest price accepted by seller. Matching bids a paired and executed. Such an auction is very popular, as many stock-exchange markets work that way, e.g. NYSE.
Auction market works different to the over-the-counter, where are direct negotiations. During auction everything is done automatically, without any possibility of negotiations. Moreover, on auction market it is possible that multiple buyers and multiple sellers deal simultaneously. There is no restriction to one seller-multiple buyers model, as in traditional auction.
That form of auction is the most efficient, as it tries to satisfy the highest possible number of investors .
According to Financial Dictionary , is a "a market in which buyers and sellers gather to transact business through announced bid and ask prices. The organized securities exchanges are examples of auction markets. Compare dealer market, open outcry".
Auctions are really important part of many markets, for example markets for radio spectrum, timber, used industrial machinery, livestock, used cars, antiques, government-owned property, procurement, debt instruments, art, charity, and real estate. Economists have developed a lot of research, including theoretical and experimental nd empirical studies. Very big amount of this work was based on effects of different auction structures, comparing common designs such as English, Dutch, first-price sealed-bid and second-price auctions.
At the beginning the auctioneer is posting a reserve price. If no buyer bids the reserve price, then no deal is done. When buyer bids the reserve price, bids are invited from the buyers, who must bid higher price than the current highest bid. When no buyer wants to raise the bid, the buyer who made the highest bid wins the object and pays the amount of his bid. Mostly English Auction is used to sell arts, antiques, wines etc.
The auctioneer starts by asking for an false high price and next lowers the asking price by a small value until some buyer makes a bid equal to the current asking price. The buyer who made the bid wins the object and pays the price. It is used in Dutch flower market, Ontario tobacco market or fish markets in Zamibia.
First-Price Sealed-Bid Auctions
Bidders report bids to the auctioneer. In a buyer-bid auction, the highest bidder wins the auction and pays the price of his bid. In a seller-bid auction, the lowest bidder sells the object and is paid the amount of her bid. We are using this auction to invited tenders, construction contracting, military procurement and private-firm procurement, refinancing credit, London Gold Exchange, etc.
Second-Price Sealed-Bid Auction (Vickrey Auction)
Bidders submit bids to the auctioneer. In a buyer-bid auction, the highest bidder wins the auction and pays the price of the second highest bid. In a seller-bid auction, the lowest bidder sells the object and is paid the amount of the second lowest bid. Usage is not as common as other auctions, but we can find it on eBay's proxy bidding and Google's AD auction use similar idea.
Examples of Auction market
- New York Stock Exchange (NYSE): The NYSE is the largest stock exchange in the world and is an auction market where buyers and sellers can trade stocks and other securities. The NYSE operates an auction market in which buyers and sellers submit bids and offers to buy or sell stocks. The highest bid is matched with the lowest offer to determine the trade price.
- London Stock Exchange (LSE): The London Stock Exchange is a major international stock exchange and auction market. It is home to a variety of stocks and other securities, and buyers and sellers can submit bids and offers to buy or sell securities. Like the NYSE, the LSE operates an auction market with buyers and sellers submitting bids and offers to buy or sell securities at the best possible price.
- Chicago Mercantile Exchange (CME): The Chicago Mercantile Exchange is a futures and options market that operates as an auction market. Like other markets, buyers and sellers submit bids and offers to buy or sell futures and options contracts. The CME also operates an auction market in which the contracts are traded according to the highest bid and lowest offer.
- Commodity Exchanges: Commodity exchanges such as the Chicago Board of Trade (CBOT) and the New York Mercantile Exchange (NYMEX) are auction markets in which buyers and sellers can trade futures and options contracts for commodities such as oil, gold, and wheat. The contracts are traded according to the highest bid and lowest offer.
- Online Auction Sites: Online auction sites such as eBay and Amazon are also auction markets. Buyers and sellers submit bids and offers to buy or sell goods and services. The highest bid is matched with the lowest offer to determine the trade price.
Advantages of Auction market
Auction markets have several advantages:
- They create an efficient and transparent market as buyers and sellers compete to get the best price. This allows for price discovery, and helps to ensure that prices are determined by the market and not by any single entity.
- They also provide liquidity, as buyers and sellers can enter and exit positions more easily.
- Auction markets offer more efficient price discovery, as buyers and sellers are able to compete to get the best price.
- Auction markets are also less susceptible to manipulation and insider trading, as the prices are determined by the collective bids and offers rather than by any single entity.
- Finally, auction markets are cost effective as trading costs are typically lower than for other types of markets.
Limitations of Auction market
- Price discovery: Because of the nature of the auction market, there is no guarantee that market participants will accurately discover the true market price. This can be due to the fact that the market is not always liquid, meaning that there may not always be enough buyers and sellers to accurately assess the true market price.
- Price manipulation: If there are not enough market participants, it can be easier for a few traders to manipulate the market and the price. This can be done through strategies such as cornering the market or spoofing.
- Information asymmetry: In an auction market, there is often an information asymmetry between buyers and sellers. This means that one party may have more information than the other, which can lead to an unfavorable outcome for the less informed party.
- Limited liquidity: Auction markets can often lack liquidity, meaning that there may not be enough buyers and sellers to ensure that the trade is completed at the desired price. This can be problematic for traders who require more liquidity to make their trades.
- Price volatility: Because of the limited liquidity in an auction market, prices can be more volatile than in a more liquid market. This can lead to more risks for traders, as prices can be more unpredictable.
- Auctions with sealed bids: A sealed bid auction is where the buyers submit bids in sealed envelopes with the highest bidder winning. This type of auction is used for high value items and is less common than the public auction.
- Vickrey auction: The Vickrey auction is a sealed bid auction where the winner pays the second highest bid price. This method is used to determine the market value for a good or service.
- Dutch auction: A Dutch auction is where the price of an item is lowered until a buyer is found. This type of auction is used to determine the market value of a good or service.
- English auction: An English auction is an open ascending auction where the price of an item is increased until a buyer is found. This type of auction is used in many stock exchanges.
In summary, other approaches related to Auction market include Auctions with sealed bids, Vickrey auction, Dutch auction, and English auction. These methods are used to determine the market value of a good or service.
- Bapna, R., Goes, P., Gupta, A., & Jin, Y. (2004). User heterogeneity and its impact on electronic auction market design: An empirical exploration. Mis Quarterly, 21-43
- Financial Dictionary "Auction Market"
- Bid Takers or Market Makers? The Effect of Auctioneers on Auction Outcomes
- Auctions: Theory and Practice
- Auctions: Theory and Practice
- Auctions: Theory and Practice
- Auctions: Theory and Practice
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- Bapna, R., Goes, P., Gupta, A., & Jin, Y. (2004). User heterogeneity and its impact on electronic auction market design: An empirical exploration. Mis Quarterly, 21-43.
- Gul, F., Stacchetti, E. (1999).The English Auction with Differentiated Commodities, Version: July 22, 1999
- Klemperer, P., (1999).Journal of Economic Surveys"Auction Theory: A Guide to the Literature", Vol. 13, No. 3
- Lacetera, N., Larsen, B. J., Pope, D.G., & Sydnor, J.R. (2013).Bid Takers or Market Makers? The Effect of Auctioneers on Auction Outcomes, October 28, 2013
- Scott, D.L.,(2003). Financial Dictionary
- Zhang, D. (2012). Auctions: Theory and Practice, September 3, 2012
Author: Maja Rogalska