Do Security‐Differentiated Water Rights Improve the Performance of Water Markets?

TLDR

Existing water markets combine rights and allocation trading, yet security‑differentiated rights could enhance efficiency and help users manage supply‑risk uncertainty. The study compares single‑level versus two‑level security designs for water rights in a laboratory experiment. The experiment pits a single‑security‑level design against a two‑security‑level design. The two‑level system raises overall profits when water‑rights transaction costs are lower than allocation‑market costs, and it improves risk allocation by letting participants trade profit variability against expected profits, a result robust to transaction costs on either market.

Abstract

Most existing water markets combine water rights trading and water allocation trading. Offering security‐differentiated water rights can make the market more efficient and allow water users to manage the risks of supply uncertainty better. We conduct a laboratory experiment which compares two designs for water rights; one with a single security level and another with two security levels. We find that a two security level system increases overall profits when transactions costs are lower on the water rights market than on the water allocation market. It also improves risk allocation by allowing subjects to trade‐off profits variability against expected profits according to their risk type and this result is robust to the existence of transactions costs on either market.