Working Paper Number
This paper uses laboratory experiments to test alternative water market institutions designed to protect third party interests. The institutions tested include taxing mechanisms that raise revenue to compensate affected third parties and a market in which third parties actively participate. The results indicate that there are some important trade-offs in selecting a policy option. Active third party participation in the market is likely to result in free riding that may erode some or all of the efficiency gains, and may introduce volatility into the market. Taxing transfers and compensating third parties offers a promising balance of efficiency, equity and market stability.