Auctioning Financial Assets; Discriminatory vs. Uniform, which Method is Preferred?

1. Auctioning Financial Assets; Discriminatory vs. Uniform, which Method is Preferred? Menachem Brenner New York University Dan Galai Hebrew University of Jerusalem Orly Sade Hebrew University of Jerusalem

2. Motivation • Treasury auctions are probably the largest primary markets in the world • Countries with well-developed financial markets use auction procedures to sell debt instruments • The common mechanisms are: discriminatory and uniform • From previous research (Bartolini and Cottarelli 97): most use discriminatory • Since then – Switches (USA) • In a global financial world – mechanism choice may play an important role

3. Commonly Employed Mechanisms • Discriminatory – Each accepted bid is filled at the prices specified by the bidder. • Uniform Price – All accepted bids are filled at a common price – the equilibrium price.

4. Uniform-Price Example Quantity = 26, Intrinsic Value (resale value) = 20

5. Discriminatory-Price Example Quantity = 26, Intrinsic Value (resale value) = 20

6. Objectives • Understand Common Practice • Understand Bidders’ Preferences • Understand the Link between Preferences and Common Practice

7. Common Practice • Surveys to treasuries and central banks around the globe via e-mail and mail. • Asked the following questions: • Does your country use mainly auctions to sell government debt instruments? • What type of auction mechanisms does your country use currently in order to sell government debt instruments? • Did your country use in the past a different mechanism to sell government debt? • Does the treasury (or the central bank) have the right to change the quantity of the debt that is being sold after viewing the demand?

8. Countries Survey • Received answers from 48 countries • Our sample consists of countries from different continents, different population, and economic size • Argentina, Austria, Australia, Bangladesh, Belgium, Brazil, Cambodia, Canada, Colombia, Cyprus, Ecuador, Fiji, Finland, France, Germany, Ghana, Greece, Hungary, Ireland, Israel, Italy, Jamaica, Japan, Korea, Latvia, Lithuania, Luxembourg, Macedonia, Malta, Mauritius, Mexico, Mongolia, Norway, New Zealand, Poland, Portugal, Sierra Leon, Singapore, Slovenia, Solomon Islands, Sweden, Switzerland, Trinidad and Tobago, Turkey, United Kingdom, U.S.A, Venezuela

9. Mechanism choices • 50%, use a discriminatory price mechanism to issue government debt • 19% use a uniform price auction • 19% use both mechanisms depending on the type of debt instruments being issued • The rest of the countries, about 12%, use a pricing format that is different than the two conventional ones

10. Bidders Preferences • Survey • The participants were asked to imagine that the market consists of 10 participants, and each participant can decide in which auction mechanism to participate. • As in reality, the decision of each member of the group affects the number of bidders that he or she will eventually be bidding against. • The design of our survey is based on Sade Schnitzlein and Zender (2006).

11. Parameters (SSZ 2006) • There were 26 widgets available to all players. • The resale value of each widget at the end of the auction was Fr. 20. • The possible price levels were Fr. 17, Fr. 18, Fr. 19, and Fr. 20. • Information: once the mechanism has been chosen and schedules have been submitted, price and quantity were set: • Uniform-Fixed • Discriminatory

12. Participants • We conducted the survey during 2004 and 2005 in 6 different countries getting a varying rate of response. • Our final sample consists of 220 participants. (USA (43.2%), Israel (22.7%), Switzerland (8.2%), Luxembourg (12.3%), Norway (7.7%) and South Africa (5.9%). • The participants: advanced business undergraduates from the USA, advanced MBA students from the USA, Israel, Luxemburg and Switzerland, Executive MBA students from Israel and Norway, bankers from South Africa that attended a risk management course and financial professionals from one of the leading financial institutions in Israel

13. Participants • On average 2.33 years of experience in the financial markets (the maximum is 25 and the minimum is zero). • 11.4% of them had direct previous experience with financial assets auctions. • 21.8% of the sample are female.

14. Main Survey Results • 91% of the participants are not indifferent to the pricing rule of the auction mechanism • Most of those that have a preference for a specific price mechanism (65.5 percent) have chosen to participate in a uniform price mechanism.

15. What may affect the mechanism Choice? • Logit regression • Work experience effect:

16. The Link… • What may explain the mechanism choice by countries? • No previous documentation about this topic • No formal model to rely on

17. [1] Based on 23 observations since we do not have the classification for the source of law of Solomon Islands. [2] Based on 19 observations since data was not available for Cambodia, Macedonia, Malta, Cyprus and Solomon Islands. [3] Based on 19 observations since data was not available for Cambodia, Macedonia, Malta, Cyprus and Solomon Islands [4] Based on 21 observations since data was not available for Malta, Cyprus and Solomon Islands [5] Based on 22 observations since data was not available for Malta and Cyprus. [6] Based on 8 observations since data was not available for Trinidad and Tobago. [7] Based on 22 observations since data was not available for Malta and Cyprus. [8] Based on 8 observations since data was not available for Trinidad and Tobago

18. Multinomial Analysis • We conducted multinomial regression analysis in order to estimate which variables affect the mechanism choice. Our dependent variable was classified as follows: • Countries that use the Uniform price mechanism = 1 • Countries that use the Discriminatory price mechanism = 2 • Countries that use both mechanisms = 3 • Countries that use other type of auctions= 4

19. Uniform Versus Discriminatory

20. Summary • The majority of potential buyers prefer to participate in a uniform price auction. • most of the global treasuries employ a discriminatory auction to sell government bonds. • The mechanism may be associated with the legal system and proxies for financial market development.