Low Reserve Prices in Auctions

Received auction theory prescribes that a reserve price which maximizes expected profit should be no less than the seller's own value for the auctioned object. In contrast, a common empirical observation is that many auctions have reserve prices set below seller's values, even at zero. This paper revisits the theory to find a potential resolution of the puzzle for second-price auctions. The main result is that an optimal reserve price may be less than the seller's value if bidders are risk averse and have interdependent values. Moreover, the resulting outcome may be arbitrarily close to that of an auction that has no reserve price, an absolute auction.