The Royal Swedish Academy of Sciences has decided to award the 2020 Nobel Prize in economics to Stanford University professors Paul R. Milgrom and Robert B. Wilson “for improvements to auction theory and inventions of new auction formats.”
“Nowadays, objects worth astronomical sums of money change hands every day in auctions, not only household objects, art and antiquities, but also securities, minerals and energy,” the Swedish institution specified. “Public procurements can also be conducted as auctions.”
According to Bloomberg, the theories of the two scientists haven’t yet found an immediate application for the renewable energy sector, but they are now being adapted by their creators for this purpose. “We have all these needs now for energy from solar power, from wind, that’s quite variable,” Wilson told Bloomberg. “So, we need to create new kinds of markets for those kinds of variable resources to keep the supply provided to meet the demand.”
Professor Wilson was recognized for having developed the concept of “common value” in auctions. Applied to the energy sector, these concepts allow for better understanding of “common value” of commodities. For example, an energy company that submits an offer to buy rights to extract natural gas is concerned with both the size of the gas reservoir, which has a common value, and the cost of extracting the gas, which has a private value, as the cost depends on the technology available to the company.
According to Stanford University, which issued its own press release on the prize, the theory associated to the “common value” showed how even the most rational bidders can overestimate the value of an item they are bidding on.
This results in what Wilson defined as the “winner’s curse,” which occurs when winners regret their successful bids because they exceed the value of the object being auctioned. “The winner’s curse can also lead cautious bidders to undervalue an item – to avoid the curse – and becomes especially problematic when bidders have different private information about an item’s true value,” the Stanford experts said.
As for Professor Milgrom, the Swedish jury has awarded in particular his general theory of auctions that considers not only common values, but also private values that can vary from bidder to bidder.
“He analysed the bidding strategies in a number of well-known auction formats, demonstrating that a format will give the seller higher expected revenue when bidders learn more about each other’s estimated values during bidding,” the Royal Academy stated.
Both professors also invented the auction format known as Simultaneous Multiple Round Auction (SMRA). “In these auctions, all biddable items are offered simultaneously and bidders can bid on any portion of the items,” Stanford University explained. “The bids start low, in order to avoid the winner’s curse, and the auction ends when no bids are placed in a round.”
The first time this auction format was used was in 1994, when the US government used their auction format to sell radio frequencies to telecom operators.
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