Published online by Cambridge University Press: 22 March 2006
Allowing water to be traded in an irrigation system with de facto riparian rights can increase the efficiency of water use. With irrigation supplementing uncertain rainfall, both supply and demand for water are uncertain. When rainfall events are positively correlated, water supply and demand movements are negatively correlated, causing large price fluctuations. Using a stylized two crop, two region irrigation system, numerical integration over a bivariate rainfall distribution is used to demonstrate the impact of varying rainfall correlation on water price, expected returns, and return variability. A spot market for water captures the majority of the returns to water rights transfers, relative to a complete market. This spot market results in higher returns and reduced return volatility for farmers in the water deficit region, while farmers in the water surplus region see greater returns but also greater return volatility.