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The Illiquidity of Water Markets

  • Donna, Javier
  • Espin-Sanchez, Jose
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    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.

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    File URL: http://mpra.ub.uni-muenchen.de/55078/1/MPRA_paper_55078.pdf
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    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 55078.

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    Date of creation: Feb 2014
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    Handle: RePEc:pra:mprapa:55078
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    1. Victor Aguirregabiria & Pedro mira, 2007. "Dynamic Discrete Choice Structural Models: A Survey," Working Papers tecipa-297, University of Toronto, Department of Economics.
    2. Victor Aguirregabiria & Pedro Mira, 1999. "Swapping the Nested Fixed-Point Algorithm: a Class of Estimators for Discrete Markov Decision Models," Computing in Economics and Finance 1999 332, Society for Computational Economics.
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