Factors Affecting Participation in Spot and Options Markets for Water

Abstract

In this paper, using a stylized mathematical simulation model, the participation of farmers in spot and options markets is analyzed in a two-period setting. Farmers assess the benefits from entering one of the two markets based upon anticipated water supplies in a subsequent period and relative expected profits in water and agricultural markets. The supply of water for urban use is a function of uncertain weather conditions and water demands for agricultural uses. The analysis offers insights on water market participation by deriving conditions that favor spot or options market participation. The findings highlight the importance of market size, agricultural profitability, and other parameters in predicting the potential success of spot and options market formation.