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Abstract
With the current drought in South-Eastern Australia highlighting the scarcity and value of
inland Australia’s water resources, focus turns to how these resources can be allocated
more efficiently. The first major step was taken almost a decade ago with the separation
of land and water property rights allowing openly traded water markets. This study
assesses the potential economic benefits that options contracts bring to the water
market in the Murray Valley water market. Exotic call options are estimated using both
Black-Scholes and skewness-and-kurtosis-amended Black-Scholes financial option
pricing methods that are based on three years of data on water prices. While the
presence of options would result in significant economic benefits in the more efficient
trade of water on the open market for lower-value crops, there were mixed results from
the attempt to price such options.