Robert Wilson Applied Game Theory to Economics and Won

At a Glance

  • Stanford economist’s contributions earn him 2017 CME Group-MSRI prize
  • Work has had a lasting influence on the energy, communications and electrical power industries

Robert Wilson’s work applying game theory to economic problems likely impacts your life every day. It affects everything from the cell towers that power our phones to the price we pay for electricity.

Wilson, a professor at the Stanford Business School since 1964, has been a seminal figure in economics for over 40 years. His research influenced an entire school of thought and every area of modern auction theory bears his mark.

As an undergraduate at Harvard he studied mathematics and stayed on to earn an M.B.A. and doctorate of business administration. Wilson points to a significant early influence from his mentor Professor Howard Raiffa at the Harvard Business School. Early on, Wilson became intrigued with Raiffa’s work in decision theory, which includes the issue of how a group of people might efficiently share risk.

Wilson began exploring the concepts of statistical decision theory and took them a step further. He played a groundbreaking role in applying game theory to the auction environment and devised solutions for economic problems where the distribution of information is key.

“Now game theory is a part of every PhD curriculum in economics,” says Andrzej Skrzypacz, Theodore J. Kreps Professor of Economics at the Graduate School of Business at Stanford University. “When Bob started his work on multi-unit auctions in the 1970s there was a lot of skepticism if game theory could bring anything new and important to economics. His vision won.”

For his contributions in pioneering game theory, and his role in its application, Wilson is the 2017 recipient of the CME Group-MSRI Prize in Innovative Quantitative Applications. The prize recognizes individuals who contribute original concepts in mathematical, statistical or computational methods for the study of the markets’ behavior and global economics.

Wilson admits he never had an interest in classical economics, where supply and demand influence price.

“I was more interested in price formation and how prices are set in competitive markets. It is not supply and demand that magically sets price. In reality, there are people bidding and calling out prices. People make offers and some get accepted and some get rejected,” Wilson says. In some of his work he pointed to the Chicago Mercantile Exchange as an example of how the auction market works.

 

Real World Applications

Wilson’s work stretched far beyond the ivory tower with many practical applications in the energy, communications and the electric power industries. The crux of his work revolves around how economic interactions unfold in situations of informational inequality. Wilson devised solutions and created auction models that facilitated cooperation in those environments.

 

Conquered the Winner’s Curse

One example is how Wilson’s economic theories tackled the idea of the “winner’s curse.” That refers to the idea that “you can only win an object in an auction by bidding more than it is worth. It is only the person who overestimates the value tends to win,” Wilson says.

In his early work, he acted as a consultant to the Department of Interior advising them on the design of auction for energy oil leases. At the time within the energy industry there was a lot of focus on the idea of the winner’s curse. He developed models of optimal bidding strategies to take that into account and sidestep the impact.

 

FCC Auction of National Airwaves

In 1993, the Federal Communications Commission (FCC) began work developing its spectrum auction to grant licenses to private companies for portions of the electromagnetic radio frequencies that transmit sound, data and video across the country. This includes your cell phone service, the ability to live stream the big game on the internet and programming on your television set.

The process was a complex undertaking as it needed to account for multiple companies who were attempting to build large national coverage networks, which required bidding for licenses all over the country, while others wanted to focus on smaller regional markets. The auction process needed to create a fair process, while also resulting in a competitive market for consumers.

Wilson, along with his former student Paul Milgrom, now a professor of economics at Stanford University, developed a model for the FCC called a simultaneous multiple round (SMR) auction. This approach replaced the traditional sealed envelope with an open bidding format, in which each company could observe what the others were offering,

 

Foiled the “Snake in the Grass”

The FCC auction model included a component to disrupt the “snake in the grass” bidding strategy which refers to someone who does not bid early on and then jumps in right at the end. “The activity rule prevented that and bidders were forced to bid early in the process and keep bidding on things they were interested in,” Wilson says.

The auctions were collectively deemed a massive success and raised over $60 billion for the federal government. Professor Skrzypacz calls the FCC auction model a design that has revolutionized the award process for wireless spectrum around the world and that is still being used today with some modifications.

Indeed, Wilson points to the successful completion of the first FCC spectrum auction in 1994 which he helped design as his most proud moment. “This had a huge impact on people’s lives as the cell phone industry got off to a really fast start. Within a year, cell phone towers were being built. The auction design really sped up the allocation of spectrum licenses,” Wilson says.

 

The California Electricity Crisis

In 2000-2001, a crisis emerged in the California electricity market after privatization in the utility industry in the late 1990s resulted in a shortage of electricity supply which triggered large-scale electric blackouts and a massive increase in electricity prices on the wholesale market.

In another example of how his research had real-life impact, Wilson applied his theories on non-linear pricing to the electric market. One example of non-linear pricing in its most simplified form equates to a quantity discount, or the more you buy the lower price per unit.

Wilson developed the concept of priority service price levels, in which customer’s contract in advance for the level of electric service they receive. The top component of priority service would, for example, continue to receive electric service even on very hot summer days, when AC usage is at its highest.

 

A Generous Teacher and Advisor

Wilson’s contributions to the field of economics spans beyond his own work and encompasses his generous and significant influence on his students, which includes two Nobel prize winners Bengt Holmstrom, professor of economics at Massachusetts Institute of Technology and the 2016 Nobel Prize in Economic Sciences recipient and Alvin Roth, professor of economics at Stanford University and the 2012 Nobel Memorial Prize in Economic Sciences recipient.

“My biggest joy is working with my PhD students. I am delighted about the wonderful successes some of them have had,” Wilson says.

Skrzypacz says Wilson’s roster of students is one of the things that set him apart. “His work with students is legendary. He has one of the very best set of advisees in all economics in the last 50 years.  He is always generous with his time and has a great vision.”

Kira Brecht has been writing and analyzing the financial markets for 20 years. She is a contributor to the Dow Jones commodity newswire and Kitco News. She's also written for Active Trader magazine, Currency Trader magazine, and the Chicago Tribune. You can follow her on Twitter @KiraBrecht

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