Impacts of water rights security on water markets: experimental evidence

Water markets are xpected to lead to e_cient use of scarce water by re-allocating water from low value uses to high value uses. However a water allocation system must not only allocate speci_c volumes of water among users but also allocate the risk of supply shortages. The existence of both a market of water rights and a spot market of water allotments is necessary to allow users to manage better the risk of increased supply uncertainty. Whether the water rights market should be further sophisticated by o_ering di_erent levels of security for rights is unclear. Indeed, increasing the complexity of water markets can eventually reduce e_ciency gains and cost-e_ectiveness of water trade. We propose an experimental design that captures the main characteristics of water markets. Farmers _rst participate in the market for water rights while facing uncertainty on water allotments. . Once the water supply is known, they can trade their water allocation on the spot market. We examine two water right scenarios, one with a unique security level and another iwith two levels of security and we compare them in terms of allocation e_ciency, risk allocation and cost e_ectiveness. We vary transactions costs as a treatment variable and elicit risk preferences of subjects. By comparing the performance of the markets in each treatment, we can measure the bene_ts of having two levels of security for water rights and test whether they are contingent on the characteristics of transaction costs and risk aversion