Competitive Analysis of Bidding Behavior on Sponsored Search Advertising Markets

Online advertisers bidding in sponsored search auctions through Web search engines are experiencing unprecedentedly fierce competition in recent years, resulting in an obvious upward trend in bids submitted by advertisers. This bid inflation phenomenon poses significant threat to the overall stability and the effectiveness of sponsored search markets. Existing research efforts, however, do not yet provide directly relevant theoretical or managerial insights to help understand this kind of real-world competitive bidding behavior in sponsored search. Our research is targeted at filling in this important research gap. Based on a model of advertisers' rational competitive preference, we propose a novel equilibrium solution concept called the upper bound Nash equilibrium (UBNE), which can be viewed as the upper bound of the output-truthful subset in the NE continuum of sponsored search auctions. We show that the UBNE can better characterize advertisers' competitive bidding behavior than other solution concepts, offering a viable theory driven behavioral explanation for bid inflation. We also show that the UBNE is a stable outcome of competitions among advertisers in repeated game settings and yields the optimal outcome for Web search engines.