Buyout options in Internet auction markets

A new selling mechanism has recently appeared on internet auction sites: a buyout option. This option allows a bidder to purchase the item at a pre-specified buyout price, instead of attempting to obtain the item through the traditional auction procedure. No general insights have been made regarding how participants should behave in such an environment.; The focus of this analysis is an auction with a temporary buyout option, which may cease to be available before the auction ends. Possible motivations for market participants to use such options are identified. The analysis centers on varying risk attitudes and time impatience by market participants.; When all agents are risk neutral and not time impatient an equilibrium is identified in which the seller chooses a buyout price which results in the option never being exercised in equilibrium. Risk aversion or time impatience on either side of the transaction can lead the seller to optimally choose a buyout price that results in the option being exercised with positive probability in equilibrium. Allowing the seller to offer such an option results in an ex ante Pareto improvement, compared to a similar auction without a buyout option, if the risk aversion or time impatience is only on the seller's side of the transaction.; Finally, the issue of whether or not it is possible for a seller to further improve upon a fixed buyout price is addressed, by examining a situation in which the seller may sequentially offer two different buyout prices. When all participants are risk neutral an equilibrium is identified in which the seller chooses a sequence of buyout prices which result in neither option being exercised. 1t is shown that a risk averse seller facing risk neutral bidders will choose a sequence of prices which result in each option being exercised with strictly positive probability. Thus, when facing risk neutral bidders, a risk averse seller will always benefit by being able to offer two distinct buyout prices, as opposed to a single fixed buyout price.