How probability weighting affects participation in water markets

Ram Ranjan*, Jason F. Shogren

*Corresponding author for this work

Research output: Contribution to journalArticle

9 Citations (Scopus)
17 Downloads (Pure)

Abstract

The behavioral tendency to overestimate probabilities of loss can affect a farmer's participation in water markets. We examine this issue with a theoretical model of a nonexpected utility maximizing farmer who places subjective weights on the actual probabilities of loss of water rights due to market transactions. The farmer bargains over sharing of surpluses with the buyer of water. The farmer then incorporates the bargaining outcome in his intertemporal expected benefit maximization problem that accounts for the possible loss of water rights due to its sale out of agriculture. Three key results emerge. First, subjective weighting of probabilities leads to discounting of resources when farmers overestimate probabilities of loss. Second, if farmers have idiosyncratic time preferences, total water supply in the market would depend on the level of heterogeneity in the population. Third, considering the case of two farmers, we find that the farmer with lower endowments bears the burden of risk reduction, whereas the one with higher endowments sells more water for profits. As the level of risk increases, however, the relative difference in risk sharing declines.

Original languageEnglish
Article numberW08426
Pages (from-to)1-10
Number of pages10
JournalWater Resources Research
Volume42
Issue number8
DOIs
Publication statusPublished - Aug 2006
Externally publishedYes

Bibliographical note

Copyright 2006 by the American Geophysical Union. Originally published as Ranjan, R., and J. F. Shogren (2006), How probability weighting affects participation in water markets, Water Resour. Res., 42, W08426, doi:10.1029/2005WR004543. Version archived for private and non-commercial use with the permission of the author/s and according to publisher conditions. For further rights please contact the publisher.

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