Monday, September 20, 2004

Financial Engineering News: Richard Lindsey One on One Interview

Richard Lindsey One on One Interview

Technically this may be more economics oriented, but given that Finance is really just applied economics anyways (and we are financial economists), I am sure you will love this interview. It is with Paul Klemperer.

If the name does not ring a bell, you should know he is one of the world's foremost auction experts. To quote the FEN piece: "Paul Klemperer is probably the best-known European auction theorist. From 1997 until 2000, he and economist Ken Binmore headed the team of analysts that advised the UK government about its sale of third-generation telecom licenses. The auction in spring 2000 raised more than five times the amount of money analysts had anticipated."

FEN is interviewer Nina Mehta.

Some of my favorite lines from the interview:

FEN: When you boil everything down, what's the real point of an auction?

Klemperer: An auction allows us to collect information about what the right price is for something when none of us knows it, and often allocates resources more efficiently. Auctions also have an important role in helping us test the basis of economic behavior. The rules are clearly defined and everyone knows what's allowed and what isn't, in contrast with most ordinary economic environments in which people have all kinds of differing objectives and all kinds of different choices. Economists study auctions for the same reason that biologists study fruit flies. A lot of biology is done by studying the fruit fly because it's a very simple organism, and biologists hope they'll get insights that help them to understand more complex organisms such as humans. Auction theory is the economist's fruit fly

FEN: One point you have repeatedly made is that a successful auction depends on its careful design. You caution that an auction should not be an off-the-rack affair

Klemperer: .....First of all, you have to use the mathematical tools of auction theory. Second, you have to think hard about the special features of the particular environment. You have to be very careful to stop any kind of cheating or collusion, or gaming of the rules. At the same time, you have to make the auction attractive to bidders. You'll never do well if you can't get people to show up to the auction. Indeed, many auctions have failed quite badly because designers did not recognize the basic need to get people to come and play the game. Finally, you've got to come up with something that's comprehensible and acceptable to the civil servants and politicians who must run the process, because they're the ones whose necks will be on the line if the process fails.

FEN: Clearly you couldn't teach the politicians math. How did you explain such a complex process to them?

Klemperer: It is important to use, wherever possible, analogies to processes they’re familiar with. Another thing that's helpful is to simulate examples

Other topics include Google (both before and after the actual sale!), and where auctions can be used in the future.

All in all a very interesting interview!

BTW I can not recommend strongly enough that you subscribe to Financial Engineering News. I really enjoy it!

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