The Illiquidity of Water Markets

Donna, Javier and Espin-Sanchez, Jose (2014): The Illiquidity of Water Markets.

Abstract

We explore a particular historical episode that switched from a market institution (auctions) to a non-market institution (fixed quotas with a ban on trading) to allocate water. This water is used by farmers for agricultural purposes; some of the farmers are liquidity constraints. We present a model in which farmers face liquidity constraints to explain why the change took place. From a positive perspective, we show that demand is underestimated if these liquidity constraints are not taken into account. We use a dynamic discrete choice model to estimate demand during the auction period; we also estimate the probability of being liquidity constrained by a farmer. From a normative perspective, auctions achieve the first-best allocation only in the absence of liquidity constraints; the quota achieves the first best allocation only if farmers are homogeneous in productivity. We compute the welfare under both institutions using the estimated parameters of the structural model.

• Item Type: MPRA Paper
• Language: English
• Keywords: Organization of Production, Institutions, Financial Markets, Market Efficiency, Water
• Subjects: D - Microeconomics > D0 - General > D02 - Institutions: Design, Formation, Operations, and Impact; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D53 - Financial Markets; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L23 - Organization of Production; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q2 - Renewable Resources and Conservation > Q25 - Water

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