Thursday, July 29, 2010
Paul Klemperer writes from Oxford:
"the Bank of England has now been running my "product mix auction" for the last two months almost exactly as set out in Section 2 of "The Product-Mix Auction: a New Auction Design for Differentiated Goods" (including "paired bids" etc.)
"Although I designed it for the financial crisis when I was consulted in 2007 after Northern Rock bank run, full implementation was slow. But it is now fully implemented and running regularly (in part, so using it is not seen as a signal of crisis).
"It's perhaps best understood as a "proxy" version of a simultaneous multiple round auction. That is, bidders input their preferences, and the auction chooses the outcome that an SMRA would select assuming straightforward bidding. Because the auction is "sealed bid", it runs instantaneously (important in the Bank's financial-market context), and it therefore also less vulnerable to collusion. Another novel feature is that the auctioneer also bids its preferences about how the proportions of different varieties that it will sell will depend upon the auction prices. (By contrast, SMRA implementations I am aware of specify the number of each type of good to be sold in advance.) It's also related to Paul Milgrom's independently-invented assignment auction, but the way bidders represent their preferences is different (easier and more general in some ways).
"The Bank's specific problem is to auction loans linked to varying qualities of collateral [to inject liquidity into the banking system rapidly], but
--charge different borrowers different interest rates reflecting the different collateral-qualities [to reduce moral hazard];
--allow market conditions, as revealed by the bids, to determine BOTH the interest-rate-premium for inferior collateral AND the proportion of inferior collateral accepted [because the Bank may neither be sufficiently informed about conditions, nor wish to send a 'signal' to the market];
--permit borrowers to specify how the collateral they supply will depend upon the auction outcome [because the interest-rate-premium is not - see above - pre-specified]
"I've advised other Central Banks. Other future applications might include other purchasing "toxic assets", selling electricity, and trading biodiversity."