Academic journal article Real Estate Economics

Price Formation under Small Numbers Competition: Evidence from Land Auctions in Singapore

Academic journal article Real Estate Economics

Price Formation under Small Numbers Competition: Evidence from Land Auctions in Singapore

Article excerpt

This article examines the price formation process under small numbers competition using data from Singapore land auctions. The theory predicts that bid prices are less than the zero-profit asset value in these first-price sealed-bid auctions. The model also shows that expected sales price increases with the number of bidders both because each bidder has an incentive to offer a higher price and because of a greater likelihood that a high-value bidder is present. The empirical estimates are consistent with auction theory and show that the standard land attributes are reflected in auction prices as expected.


This article examines the price formation process under small numbers competition. The neoclassical competitive bid price model envisions an implicit auction in which the highest bidding land use obtains the land and competition among atomistic agents drives profits to zero. The model provides the foundation for modern land use theory and underlies most applied property markets analysis. The framework is easy to apply and capable of predicting how a variety of factors, including risk, affect the market price of land. The question of price formation, however, is subsumed within the competitive zero profit condition and therefore, by construction, the standard bid price model is not designed to evaluate the consequences of situations in which finite numbers of agents interact.

The literature has taken several alternative paths to study price formation in real estate markets. One approach focuses on the search and matching aspect of many property markets (particularly the housing market), an extensive line of literature that is growing rapidly. A second approach focuses on the negotiation process often observed in face-to-face real estate market transactions, typically relying on Nash bargaining or similar equilibrium constructs to model price formation. The empirical evidence in this line of literature is much less extensive, depending as it does upon data that is not widely available. These two approaches are similar in that they diverge from the standard competitive bid price equilibrium assumption, but differ in the market dimension upon which they focus; the role of search versus bargaining power in determining selling price. The third approach studies the performance of structured markets, like formal auctions, in which price formation is determined by well-defined rules governing bidding and acceptance by finite numbers of buyers and sellers. (1)

This article takes the third approach to studying price formation under small numbers competition. It begins with the recognition that the neoclassical bid price model depicts prices "as if" determined by auctions (although the structure of the implicit auction is not spelled out in any but the vaguest terms). It follows the logical connection of the implicit bid price-auction market nexus, beginning with a formal model of an auction process that yields the bid price formulation as a limiting case, and then using the model to study the properties of the expected auction outcome as the finite number of participants varies.

Even though there are not many empirical studies of real estate auctions, the few that have been published are beginning to build a picture of regularities and anomalies. For example, open-bid real estate auctions often restrict bidding by potential buyers to take place in a fixed location during a limited time period. There is a growing consensus that real estate sold in such auctions appears to sell at a discount relative to full exposure to a market comprising searching buyers who are free to make offers on a specific property as long as it remains unsold (Ashenfelter and Genesove 1992, Mayer 1998, Allen and Swisher 2000, Ching and Fu 2003). Other aspects of open-bid real estate auctions, however, are not so clear-cut. For example, while Lusht (1994) and Mayer (1998) find that auction prices tend to decline for units sold later during a sequential auction of multiple units, (2) Allen and Swisher (2000) find that selling prices tend to increase for properties sold in sequence as the auction proceeds. …

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