Water rights for variable supplies

The relative merits of different systems of property rights to allocate water amongdifferent extractive uses are evaluated for the case where variability of supply isimportant. Three systems of property rights are considered. In the first, variablesupply is dealt with through the use of water entitlements defined as shares of the totalquantity available. In the second, there are two types of water entitlements, one forwater with a high security of supply and the other a lower security right for the residualsupply. The third is a system of entitlements specified as state-contingent claims.With zero transaction costs, all systems are efficient. In the realistic situation where transactioncosts matter, the system based on state-contingent claims is globally optimal,and the system with high-security and lower security entitlements is preferable to thesystem with share entitlements.