This paper contains a review of the burgeoning research that has been designed to shed light on how the art auction system actually works and what it indicates about price formation.First, we find that in recent years returns on art assets appear to be little different from returns on other assets.In addition, some researchers have found that because of the weak correlation between art asset returns with other returns, there may be a case for the inclusion of art assets in a diversified portfolio.Second, we find evidence of several anomalies in art market pricing.The evidence clearly suggests that, contrary to the view of the art trade, "masterpieces" underperfo rm the market.In addition, there is considerable evidence that there are fairly long periods in which art prices may diverge across geographic areas and even auction houses.Third, we review the public record of the criminal trial of Sotheby's former Chairman, who was accused of price fixing, to show how the collusion with Christie's, the other great public auction house, was actually engineered.Contrary to the way the proceeds from the settlement of the civil suit in this case were distributed, we sho w that buyers were almost certainly not injured by the collusion, but that sellers were.In addition, based on the public record of settlement, it appears that the plaintiffs in the civil suit were very handsomely repaid for their injury.Finally, we review the extensive research on the effects of the auction institution on price formation.There is now considerable theoretical research on strategic behavior in auctions, much of it in response to empirical findings, and we review three key findings.First, the evidence suggests that art experts provide extremely accurate predictions of market prices, but that these predictions do not optimally process the publicly available information.Second, high reserve prices, and the resulting high unsold ("buy-in") rates are best explained as optimal search in the face of stochastic demand.Third, extensive research has documented that the prices of identical objects are more likely to decline than to increase when multiple units are sold, and this has led to considerable theoretical research.Subsequent empirical research has tended to document declining demand prices even when the objects are imperfect substitutes.

This paper contains a review of the burgeoning research that has been designed to shed light on how the art auction system actually works and what it indicates about price formation. First, we find that in recent years returns on art assets appear to be little different from returns on other assets. In addition, some researchers have found that because of the weak correlation between art asset returns with other returns, there may be a case for the inclusion of art assets in a diversified portfolio. Second, we find evidence of several anomalies in art market pricing. The evidence clearly suggests that, contrary to the view of the art trade, masterpieces underperform the market. In addition, there is considerable evidence that there are fairly long periods in which art prices may diverge across geographic areas and even auction houses. Third, we review the public record of the criminal trial of Sotheby`s former Chairman, who was accused of price fixing, to show how the collusion with Christie`s, the other great public auction house, was actually engineered. Contrary to the way the proceeds from the settlement of the civil suit in this case were distributed, we show that buyers were almost certainly not injured by the collusion, but that sellers were. In addition, based on the public record of settlement, it appears that the plaintiffs in the civil suit were very handsomely repaid for their injury. Finally, we review the extensive research on the effects of the auction institution on price formation. There is now considerable theoretical research on strategic behavior in auctions, much of it in response to empirical findings, and we review three key findings. First, the evidence suggests that art experts provide extremely accurate predictions of market prices, but that these predictions do not optimally process the publicly available information. Second, high reserve prices, and the resulting high unsold (buy-in) rates are best explained as optimal search in the face of stochastic demand. Third, extensive research has documented that the prices of identical objects are more likely to decline than to increase when multiple units are sold, and this has led to considerable theoretical research. Subsequent empirical research has tended to document declining demand prices even when the objects are imperfect substitutes.

The failure of many paintings to sell in art auctions indicates the presence of reserve prices set by sellers. This paper examines the relationship between sale rates and price surprises over time in art auctions. Using data on contemporary and impressionist art, we show that while sale rates appear to have little relationship to current prices, there exists a strong positive relationship of sale rates to unexpected aggregate price changes, which is reminiscent of a Phillips curve. As a result, sale rates provide a useful quantity indicator of the strength of the art market. The data also indicate that sale rates revert to "normal" very quickly following a price surprise. We estimate an empirical model to measure normal sale rates. We also find evidence that the reserve price is set on average at about 70% of the auctioneer's low estimate, as published in the auction catalog.

This paper shows that the price of a painting sold at an art auction and the experts' pre-sale valuations are anchored on the price at which the painting previously sold at auction. We are able to separate anchoring from rational learning by using the identifying strategy that the unobservable component of quality for a particular painting remains constant between the last auction sale and the current auction sale. We interpret these results as anchoring on the part of the buyers, with the sellers and auctioneers either anticipating anchoring on the part of the buyers or exhibiting anchoring effects themselves.

In markets where prices are determined by the intersection of supply and demand curves, standard identification results require the presence of instruments that shift one curve but not the other. These results are typically presented in the context of linear models with fixed coefficients and additive residuals. The first contribution of this paper is an investigation of the consequences of relaxing both the linearity and the additivity assumption for the interpretation of linear instrumental variables estimators. Without these assumptions, the standard linear instrumental variables estimator identifies a weighted average of the derivative of the behavioural relationship of interest. A second contribution is the formulation of critical identifying assumptions in terms of demand and supply at different prices and instruments, rather than in terms of functional-form specific residuals. Our approach to the simultaneous equations problem and the average-derivative interpretation of instrumental variables estimates is illustrated by estimating the demand for fresh whiting at the Fulton fish market. Strong and credible instruments for identification of this demand function are available in the form of weather conditions at sea.