Introduction

Since being pioneered by the U.S. in 1994, simultaneous ascending auctions have become a common mechanism to allocate spectrum rights. Spectrum auctions can involve billions of dollars and companies bidding in these auctions regularly create specialized bidding teams and hire experts in auction theory to develop bidding strategies. Nevertheless, the results can be surprising. In the FCC's auction of Advanced Wireless Service spectrum, price arbitrage failed so dramatically that one new entrant was able to purchase essentially nationwide coverage for about a third (more than a billion dollars) less than what incumbent carriers paid for equivalent spectrum in the same auction. At the same time, the other prospective nationwide entrant exited the auction early and filed a letter with the FCC claiming that the auction rules disadvantaged new entrants!

Results of this sort raise questions for economists. Does the apparent failure of the Law of One Price indicate a fundamental flaw in auction design? If not, why must such auctions be complicated? What are the issues that create strategic complexity for bidders? And to what extent can the tools of economic theory provide insights that facilitate effective bidding in highly complex environments?

We start by explaining some of the reasons why large spectrum auctions are necessarily complicated, and why the Law of One Price can fail so dramatically in a spectrum auction.We emphasize two difficulties facing bidders: exposure problems, which are essentially the problems of bidders wishing to acquire complementary licenses, and budget constraints, which we argue are ubiquitous.We explain why these difficulties make bidding in simultaneous ascending auctions complicated, and also why they would complicate bidding in other auction designs.

Exposure problems create fundamental difficulties for a new entrant seeking to compete head-to-head with incumbent nationwide wireless carriers in the US. Such an entrant needs to acquire adequate bandwidth in every major metropolitan area, but because licenses covering cities or regions are sold individually, the entrant could commit to spending billions of dollars winning spectrum licenses before discovering that the total price for the bundle of licenses it seeks makes the whole entry unaffordable or unprofitable. It could then be left to dispose of extensive holdings at fire-sale prices.