The Microstructure of Water Markets: Bargaining vs. Auctioning Approaches Dafna M. DiSegni Eshel Department of Agricultural and Resource Economics University of California, Davis December 8, 2002 Abstract In this paper, we are interested in evaluating the following thought experiment: When a resource is publicly owned, what are the efficiency implications of applying an auctioning mechanism for allocating the resource (water) among individuals (farmers), rather than allocating use rights among agents, and at a second stage allowing trade (bargaining) in rights among individuals? The conceptual difference between the two approaches arises from the difference in ownership allocation of the public resource. We find that the efficiency of evolving water markets depends on the initial allocation of water use rights and their trade microstructure. In particular, we show that bargaining may be inefficient relative to an auctioning trade approach. The theoretical analysis is followed by a discussion on the impact of applying each of the trading approaches to water reallocation in Israel, a classical case study in which water is publicly owned. Selected Paper, Workshop on Water and Agriculture The Hebrew University, Israel, December 2002. Keywords: tradable rights, water, market microstructure, auction, bargaining. JEL Classification Numbers: D4, D61, D82, F18, Q25 Corresponding author: Dafna M. DiSegni Eshel, Department of Agricultural and Resource Economics, University of California, Davis, CA 95616 disegni@primal.ucdavis.edu. I Thank James Eaves, Siwa Msangi, Rachael E. Goodhue , Richard E. Howitt for insightful suggestions and corrections. 1