THE LAW OF ONE PRICE: A TEST ON AUCTIONED WINE IN HONG KONG AND NEW YORK

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1 THE LAW OF ONE PRICE: A TEST ON AUCTIONED WINE IN HONG KONG AND NEW YORK Kelley D. Ritchey Ph.D. Candidate, College of Management Mahidol University Lecturer, Asian University kd7@hotmail.com INTRODUCTION This paper uses the return of wine auctions to Hong Kong beginning in 2008 to test the Law of One Price, the notion that identical goods should be priced the same after converting to a common currency. My results, after pairing similar wine lots by vineyard, vintage, bottle and lot size, and pre-sale estimates in Hong Kong and New York, suggest a violation of the Law of One Price in 2009 at one auction house, with the more acute mispricing found in lower-priced wines. The Asian wine market has developed over the last two years after an elimination of duties on wine in Hong Kong in February 2008, which had been as high as 80% in early 2007 (Booth, 2007). While one of the anticipated effects of the change was to create Hong Kong as a third wine hub, behind New York and London (Lau, 2008; Cheng, 2008), more recent articles in the press suggested Hong Kong may have already surpassed New York and/or London as a wine center and Asians may now already account for a majority of global wine sales at Christie s (Pomfret, 2009). Hong Kong s emergence as a wine center has been supported by auction activity. Four auction houses (Bonham, Acker Condit Merrall, Zachys, and Christie s) held six auctions in Hong Kong during 2008, grossing over $27 million U.S. dollars and five auction houses (with the addition of Sotheby s) conducted 15 auctions, grossing almost $50 million in 2009.

2 While reports of auction results tend to focus on either the sales records from a few choice lots (which might result from exceptionally good provenance) or the overall sales gross relative to estimates, the existence of multiple auction locations offers a unique opportunity to test the Law of One Price, the notion that identical goods should be priced the same after converting to a common currency. Deviations from parity are possible with trade barriers or policies, exchange rate variability (Cheung and Fuji, 2008) and transportation costs (Crucini and Shintani, 2006). The testing of the Law of One Price is not without difficulties. Both early (Isard, 1977) and later research (Cheung and Fuji, 2008; Broda and Weinstein,2008 ) suggested that aggregate price indices could not be used to test the law of one price in its absolute form and even narrowlydefined products in different counties (excepting primary commodities) may not be perfect substitutes for each other. Attempts to test the absolute version of the Law on One Price have depended on comparisons where quality and quantity assessments can be matched within precise product definitions (Crucini and Shintani, 2006; Cheung and Lee, 2008). Others have used auction data to test the Law of One Price. Ashenfelter (1993) credited his observation of the declining price anomaly on identical lots of wine offered sequentially within the same sale for his later research on wine auctions. Raviv (2004) explored the declining price anomaly with heterogeneous goods, specifically used cars sold at public auction in New Jersey. Pesando (1993) examined print prices for a variety of artists in the period and found higher prices in the U.S. versus London and Europe by 7-10%. Pesando & Shum (2007) examined the auction market for Picasso prints and found different impressions of the same print sold at auction at approximately the same time in different locations yielded different prices in the U.S. and Europe over a longer time period. In addition, Sproule and Valsan (2006) performed hedonic regressions for pre-sale estimates 2300 pieces of abstract art from five artists and find that the geographical location of the auction had a statistically significant relationship on price. The research questions are as follows:

3 First, do realized prices for fine wine sold at auction in Hong Kong and New York by the same auction house nearly simultaneously satisfy the law of one price, or are there systematic differences as a result of country of origin, vintage, price level, or other factors? Second, to the extent that there are differences, do the violations appear to be diminishing over time? As suggested by Pesando (1993), we would expect that any discrepancy between prices in the two markets would lessen over time, once the violation of one price was noticed. We would expect consigners to sell their lots in the market offering the highest expected price and buyers to seek the market with the lowest expected prices, inclusive of transportation costs. DATA The data consisted of prices realized at auctions contemporaneously in Hong Kong and New York for lots of fine wine offered by a single auction house, Zachys, in four pairs of auctions during the calendar year Following Pesando and Shum (2007), we define auctions as contemporaneous if they occurred at the two locations within 30 days of each other. The four auctions paired in 2009 (in April/May, June, September, and October) were held on average less than 14 days apart. Given that the auctioneer prepares a catalog many weeks before the event, the information set is assumed to be near identical and would not include prices of the earlier auction of the paired set. The use of a single auction house for this study eliminates issues raised by Pesando (1993), Raviv (2004) and Sproule and Valson (2006) of significantly different prices realized at different auction houses. To test for the Law of One Price, lots are matched on the following criteria: vineyard, vintage, bottle and lot size. If lots are matched on these four criteria, it is assumed they are identical. However, it is possible that lots matched by these characteristics differ significantly on another dimension, perhaps the condition of the lot. Pesando and Shum (2007) described a similar issue in Picasso prints and implemented a procedure to eliminate potential pairs with divergent estimates due to either cataloging errors or lot condition differences. Although Pesando and

4 Shum (2007) rejected matched pairs with realized prices differing by 100% or more, we reject a pair if the low estimates differ by more than 10%. RESULTS For the four pairs of 2009 auctions studied, we find a total of 175 pairs of identical lots trading within a 30-day window with identical price estimates. We find that the Hong Kong realized price is greater than the New York realized price 62% of the time, which represents significance at 1% against a null hypothesis of a random outcome (50% of the realized prices higher in Hong Kong) using a binomial test. Additionally, we find the percentage price change is 5.5% higher on Hong Kong lots overall, which represents significance at 1% against a null hypothesis of no difference in price. Broader definitions of nearly identical price estimates (195 lots and 224 lots) were tested with the same conclusions. Further tests are conducted on law of one price on lots in different price categories and over time. The most mispriced bottles relative to a law of one price assumption are in the lowest priced category, while it appears that over time, the violations are diminishing over time.

5 SELECTED REFERENCES Anderson, Kym (Ed.). (2004). The World s Wine Markets: Globalization at. Work. Northampton, MA/Cheltenham & Camberley, UK: Edward Elgar. Ashenfelter, Orley (1989). How Auctions Work for Wine and Art, The Journal of Economic Perspectives, Vol. 3, No. 3 (Summer, 1989), pp Booth, Meredith (2007, April 17). Hong Kong halves wine tax, Herald Sun. Accessed February 27, 2010 at Broda CM & Weinstein, DE (2008). Understanding International Price Differences Using Barcode Data, NBER Working Paper No. W14017 May, Cheng, Jonathan (2008, June 4). Hong Kong Seeks Wine Trade, Wall Street Journal. (Eastern edition). New York, N.Y.: Jun 4, Cheung, Yin-Wong & Fuji, Eiji (2008). Deviations from the Law of One Price in Japan, CESIFO Working Paper No. 2275, April Crucini, Mario J. & Shintani, Motosugu (2006). Persistence of Law-of-One Price Deviations: Evidence from Micro Data, Working Paper No. 06-W16, Department of Economics, Vanderbilt University. Isard, Peter (1977). How Far Can We Push the Law of One Price? The American Economic Review, Vol. 67, No. 5 (December, 1977), pp Lau, Justine (2008, February 2). Wine exchange weighs HK as hub, Financial Times (Asian Edition), p. 4. Lau. Joyce Hor-Chung (2008, June 1). Record smashed, Hong Kong wine auction proves a hit, New York Times, Lee, Hyunok & Huang, Jikun & Rozelle, Scott & Sumner, Daniel (2009). Wine Markets in China: Assessing the Potential with Supermarket Survey Data, Journal of Wine Economics, Volume 4, No. 1. Mei, Jianpang & Moses, Michael (2002). Art as an Investment and the Underperformance of Masterpieces, The American Economic Review, Vol. 92, No. 5 (Dec., 2002), pp Pesando, James E. (1993). Art as an Investment: The Market for Modern Prints, The American Economic Review, Vol. 83, No. 5 (Dec., 1993), pp

6 Pesando, James E & Shum, Pauline M. (2007). The law of one price, noise and irrational exuberance : the auction market for Picasso prints, Journal of Cultural Economics, 31: Pomfret, James (2009, October 5). Hong Kong wine auctions overtake London, New York, Reuters India. Raviv, Yaron (2004). New Evidence on Price Anomalies in Sequential Auctions: Used Cars in New Jersey. Claremont McKenna College Working Paper Series WP Richardson, Michael (1997, May 9). Asia s New Red Revolution? It Comes in a Wineglass, New York Times. Sproule, Robert & Valsan, Calin (2006). Hedonic Models and Pre-Auction Estimates: Abstract Art Revisited. Economics Bulletin, Vol. 26, No. 5 pp Walters, Peter G.P. & Saimee, Saeed (2003). Executive Insights: Marketing Strategy in Emerging Markets: The Case of China, Journal of International Marketing, Vol 11, No. 1, 2003, pp Yu, Sun, Goodman, Chen & Ma (2009). Chinese Choices: A Survey of Wine Consumers in Beijing, International Journal of Wine Business Research, Vol. 21, No. 2, pp