Galetovic, Alexander: Least-Present-Value-of Revenue Auctions and Highway Franchising
World Conference Econometric Society, 2000, Seattle

Edurdo Engel, Universidad de Chile and NBER
Ronald Fischer, Universidad de Chile
Alexander Galetovic, Universidad de Chile
Least-Present-Value-of Revenue Auctions and Highway Franchising
Session: C-11-1  Tuesday 15 August 2000  by Galetovic, Alexander
This paper presents a model for studying auctions of highway franchises. We assume the regulator is not allowed to make transfers to the franchise holder, demand for the highway is stochastic, firms are unable to diversify risk completely due to agency problems, and highways may become congested. We characterize the socially optimal risk sharing contract and show that it can be implemented with a Least Present Value of Revenue (LPVR) auction, that is, an auction where firms bid the present value of toll revenue they require to build and maintain the road. The optimal auction does not require that the regulator know firms' construction costs. We also show that fixed-term franchises currently in use are suboptimal. Furthermore, for demand uncertainty and risk aversion parameters typical of developing countries, welfare gains associated with substituting a LPVR auction for a fixed-term auction are large (e.g., one third of the cost of the highway).

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