Modelling of pricing and market impacts for water options

SummaryThe paper conceptualises new environmental derivatives, water options, which can be used as an important leverage to facilitate the growing Australian water market. A model of water option pricing has been developed. This model is based on the theory of stochastic processes with jumps. The developed model is justified by analysis of real price dynamics in water market in northern Victoria, Australia. The price of European call options is modelled as a Brownian motion and compound Poisson process. The numerical simulation for modelled water and option prices is obtained for a set of predefined jumps and hypothetical water price. Potential impacts of the introduction of water options on irrigators and the water market are discussed.