The importance of being discrete: on the inaccuracy of continuous approximations in auction theory

Abstract: While auction theory views bids and valuations as continuous variables, real-world auctions are necessarily discrete. In this paper, we use a combination of analytical and computational methods to investigate whether incorporating discreteness substantially changes the predictions of auction theory, focusing on the case of uniformly distributed valuations so that our results bear on the majority of auction experiments. In some cases, we find that introducing discreteness changes little. For example, the first-price auction with two bidders and an even number of values has a symmetric equilibrium that closely resembles its continuous counterpart and converges to its continuous counterpart as the discretisation goes to zero. In others, however, we uncover discontinuity results. For instance, introducing an arbitrarily small amount of discreteness into the all-pay auction makes its symmetric, pure-strategy equilibrium disappear; and appears (based on computational experiments) to rob the game of pure-strategy equilibria altogether. These results raise questions about the continuity approximations on which auction theory is based and prompt a re-evaluation of the experimental literature.