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Within the EU, it is agreed that watershed-based management of water quality problems is likely to be more economically efficient compared to existing institutional arrangements. Watershed authorities, assigned under the European Water Framework Directive, do however lack financial resources for policy implementation. EU funding for agri-environmental measures is mainly channeled through CAP via national governments to the farmers. In this paper, a mechanism for allocating international funds to watershed authorities is investigated assuming that there is a risk of moral hazard on behalf of the regional authority. The assumed purpose of the funding is to reduce nitrogen loads to the Baltic Proper, and the implications of uncertainty about the risk of climate change are investigated. Results shows that the risk premium associated with the presence of moral hazard can be high if there is a high likelihood of climate change and marginal damage is increasing rapidly in loads.


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