The influence of a conservation insurance mechanism on optimal bidding in risky conservation auctions

Abstract

Conservation auctions or tenders (CTs) are gaining popularity globally due to their ability to generate efficiency gains with limited public funding. However, the existence of various types of uncertainties, in particular, the cost of delivering environmental goods (own-cost uncertainties), can undermine the attractiveness of CTs as a conservation policy instrument. This paper uses the optimal bidding model to examine the bidding behaviour of risk-neutral and risk-averse bidders. We incorporate a security loading factor, which reflects a bidder's confidence in the data used to estimate the expected profit. The factor relates to the risk of facing the winner’s curse, that is, win the auction but experience higher than predicted cost. We then explore the impact of introducing an embedded insurance (a conservation insurance mechanism that is included in a successful conservation contract) on the expected profit as well as bidders' optimal bidding behaviour. We find that in the presence of own-cost uncertainty, the optimal bid rises due to the increased cost of participating in the auction. This is true for both risk-neutral and risk-averse bidders. However, in the presence of a conservation insurance mechanism the optimal bid reduces.