Reservation price

Similarly, in finance, the reservation price—also called the indifference price—is the value at which an investor would be willing to buy (or sell) a financial security given his or her particular utility function.

[6] To assist in this, three types of information can be collected from the other party through engaging in pre-contractual conversation with them:[7] In the basic model of optimal auction design developed by Roger Myerson (1981), the optimal reservation price (i.e., the smallest admissible bid) is independent of the number of bidders.

For example, if every bidder's valuation is drawn independently from a uniform distribution on the interval [0,100], then the optimal reservation price is 50.

According to traditional economic theory, the optimal reservation price results from balancing two opposing effects.

First, a higher reservation price is desirable for the seller since it deters bidders from falsely claiming that they have only a small valuation.

Second, a higher reservation price is undesirable for the seller since it deters bidders with truly small valuations from participating in the auction.

[9] In particular, Rosenkranz and Schmitz (2007) have argued that a reservation price can serve as a reference point when bidders have preferences as studied in prospect theory.

[10] In a newer model of auction theory proposed by Gunay, Meng and Nagelberg (2013), different assumptions are made.

This change in assumptions leads to a different outcome than was found by Myerson, in that the optimal reservation price is impacted by the number of bidders, and the optimal reserve price found when the weighted average of the virtual valuations of potential buyers is set to equal the value estimate the seller has for the object.