Bidding with Securities under Risk Aversion: The Role of Steepness as Insurance

In a security-bid auction, the stochastic revenue of the project being auctioned is used as an asset to securitize the winner's payment to the seller. De Marzo et al. (2005) show that in an environment with risk-neutral seller and bidders, steeper securities increase the seller's expected revenue but do not affect the efficiency of the auction. We introduce risk-averse bidders to analyze the insurance role of steepness and its implications for revenue, efficiency and bidders' endogenous participation. Steeper securities provide more insurance because they allow bidders to smooth payoffs across realizations: asking for lower payments when revenue realizations are low and for higher payments when realizations are high. We show that such insurance levels the field for more risk-averse bidders, inducing them to bid more aggressively and improving the revenue and the allocative efficiency of the auction. In addition, we present two results that are novel to the auction literature. We show that if bidders are homogeneously and sufficiently risk-averse (i) a call option is the only security that guarantees Pareto efficiency; and (ii) steeper securities attract more entry when bidders do not know their signals and entry is costly.