Stanford economists awarded Nobel Prize for work on auction theory

Stanford economists awarded Nobel Prize for work on auction theory

Stanford University professors Paul Milgrom and Robert Wilson have been awarded the 2020 Nobel Prize in economics for esoteric insights that have brought order to the power grid, mineral rights and other critical but complex parts of our economy.

Their discoveries pioneered a new approach to how auctions work – and now serve as the conceptual underpinning of bids for services that are difficult to sell in a traditional way, such as bands of radio spectrum and cell service licenses.

Their strategy can be used to improve the allocation of respirators and Personal Protective Equipment in future pandemics. In the early days of the COVID-19 crisis, states bid against each other for supplies, escalating prices and creating chaos.

When the Federal Communications Commission takes bids to allocate radio spectrum for fiercely competitive telecommunication licenses – cell phone rights in northern and southern California markets, for example – it enlists Milgrom’s and Wilson’s strategy.  This approach has been adopted in countries around the world.

“This year’s Laureates in Economic Sciences started out with fundamental theory and later used their results in practical applications, which have spread globally. Their discoveries are of great benefit to society,” Peter Fredriksson, chair of the Nobel prize committee, said in a statement.

Neighbors on campus, the two long-time friends and collaborators were startled by Monday morning’s news. Wilson, professor emeritus at the Stanford Graduate School of Business, was Milgrom’s mentor. Milgrom is a professor in the university’s School of Humanities and Sciences.

Wilson’s phone ringer was on ‘silent’ mode, so the Nobel committee called his wife instead. Milgrom, sound asleep, was also incommunicado.

In the predawn darkness at 2:15 a.m., Wilson and his wife Mary crossed the street and repeatedly rang the video-activated doorbell to awaken Milgrom. The drama is recorded on Milgrom’s Nest home security camera.

“Paul, it’s Bob Wilson. You’ve won the Nobel Prize,” shouted Wilson.

After a short pause to take in the news, Milgrom responded, “Wow, yeah. Okay.”

Their auction strategy is nothing like you’d see at a county fair, Sotheby’s art or charity event, where bidders sequentially bid up the value of a tangible item until it is sold. Instead, it’s complex and algorithmically assisted, borrowing from analytical tools used in game theory.

That’s because the value of a property often depends on the value of other properties, also up for auction. Companies are more likely to bid if they understand the possible trajectory of prices in each market, simultaneously, as well as the intent of their competitors.

Before Milgrom and Wilson’s concept, bidders in complex auctions of telecommunication spectrum were faced with big strategic uncertainties. Companies didn’t know whether or not they could acquire coverage in every other state, and how much that other coverage would cost.

The economists were inspired after a phone call from the phone company Pacific Bell, which was weighing in on the design of the FCC’s spectrum auction in the early 1990s.

They created a way for multiple bidders to bid on multiple licenses in multiple markets. When an auction round ends, bidders can view the highest offer in each market.

This approach was first used by U.S. authorities in 1994, ensuring that taxpayers were benefiting from the sale of radio frequencies that were owned by the government but of enormous value to mobile network operators.

It has since been adopted in many other realms, from kidney allocation to bidding on precious minerals.

“De Beers (diamond dealers) used to just hand a bag of diamonds to a dealer and say ‘Take it or leave it,’” said Wilson. “We created an auction system in Antwerp that supplanted a large part of the market from the monopoly power of the dominant supplier, De Beers.”

During the early days of the COVID-19 pandemic, “We had such a chaotic system,” said Wilson.

“We don’t just want prices going through the roof,” he said. “We need well-thought out systems.”

Committed to greater public understanding of the field, last week Milgrom presented his work on auction theory to youth at Saratoga High School’s economics club.

Monday’s honor will open the door to other intellectually daring concepts, he said.

“There are times that I have ideas and people think, ‘That’s too novel, that’s crazy, we’re not going to try that,’” he said. “I think that one of the effects of a prize like this is that people will pause before rejecting,” he said. “They’ll take things more seriously, and that will help me make novel things happen.”

The prize for economics is officially known as the Sveriges Riksbank Prize in Economic Sciences. It was established by Sweden’s central bank and has been awarded since 1969 in memory of industrialist Alfred Nobel.

Milgrom and Wilson will share 10 million Swedish kroner ($1.1 million) in prize money.

Wire services contributed to this report.

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