State-contingent modelling of the Murray Darling Basin: implications for the design of property rights

Questions relating to the allocation and management of risk have played a central role in the development of the National Water Initiative, particularly as it has applied to the Murray- Darling Basin. The central issues of efficiency and equity in allocations are best understood by considering water licenses as bundles of state-contingent claims. The interaction of property rights and uncertainty regarding water flows, production and output prices is modelled using a state-contingent representation of production under uncertainty. The role of technology and investment in the determination of efficient adaptation strategies to manage risks is explored using an illustrative example.