Scandinavian Working Papers in Economics

Working Paper Series,
Swedish University of Agricultural Sciences, Department Economics

No 2016:9: Selling real assets: the impact of idiosyncratic project risk in an auction environment

Luca Di Corato () and Michele Moretto ()
Additional contact information
Luca Di Corato: Department of Economics, Swedish University of Agricultural Sciences, Postal: Department of Economics, Box 7013, Swedish University of Agricultural Sciences, SE-750 07 Uppsala, Sweden
Michele Moretto: Department of Economics and Management, University of Padova, Postal: Department of Economics and Management, University of Padova, Via Del Santo, 33, 35123 Padova, Italy,

Abstract: Consider a seller auctioning a real asset among n agents. Each agent contemplates a specific investment project and the asset is crucial for its activation. Project cash flows and their volatility are private information. A first-price auction is considered and the asset is granted in exchange for a payment to be paid at the investment time. Here we determine the optimal bid function and show that the auction is efficient. The asset is assigned to the project characterized by the highest volatility in the associated cash flows. Interestingly, the bid does not depend on the time at which the project is actually executed or on the changes in post-auction cash flows. We also address concerns about the distribution of the project value among the parties and show that i) the winner always holds the largest share of the ex-post project value when projects are characterized by sufficiently high cash flow volatility and ii) negative systematic risk reduces, ceteris paribus, the share accruing to the seller. Finally, we show that cash flow volatility has an ambiguous effect on losses due to the presence of information asymmetry.

Keywords: first-price auctions; procurement; idiosyncratic risk; adverse selection; moral hazard; continuous-time models

JEL-codes: C61; D44; D82

40 pages, August 29, 2016

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