Examining volatility dynamics, spillovers and government water recovery in Murray-Darling Basin water markets

Abstract Although participation in water markets is widespread among irrigators in the Murray-Darling Basin of Australia, there has been a lack of study on the dynamics of water markets, in particular price and volume dynamic responses, volatility and spillovers. Questions have also been raised regarding the impact on markets from governments buying back permanent water from consumptive use to return to environmental use. VARX-BEKK-GARCH time-series regression was used to model the water market dynamics of monthly permanent and temporary water market trade from 1997-2017 in one of the largest water markets in the Murray-Darling Basin, the Goulburn. Results suggest that volatility in the permanent water market was less than the temporary market, while persistency in volatility only exists in permanent markets. Unidirectional transmission spillovers exists in both markets from prices to volumes. The main drivers of temporary water prices were water scarcity related, while permanent prices were most significantly influenced by previous permanent water prices and current temporary water market prices. A statistically significant negative impact on temporary volume-traded from government water recovery (e.g. a 1% increase in water recovery resulted in a 0.14% reduction in water volume-traded) was found, but no significant impact was found on temporary water prices, nor on permanent market prices and volumes. However, government water recovery increased the volatility of temporary market prices and volumes, signaling increased issues of risk and uncertainty for irrigators engaging in temporary water markets.