Pro-rata mechanisms in groundwater markets
Igor Cialenco, Michael Ludkovski, Gael Dimitri Tekam Fongouo
Abstract
We introduce a pro-rata rationing mechanism for resolving supply-demand imbalances in groundwater markets, extending the price-formation model of Cialenco and Ludkovski (2025). We show that under the pro-rata distribution, every price is a Nash equilibrium, thereby pro-rata approach provides a rationing device whenever supply and demand fail to match. By the very nature of the pro-rata mechanism, the resolution of supply-demand imbalances is unique, and the proportional rationing approach is fair. First, we consider markets with exogenous restrictions on the amounts each agent may buy and/or sell, deriving closed-form first-best consumption and characterizing how one-sided caps monotonically shift the Pareto price, while two-sided caps have an ambiguous effect. These results give the market-maker (or regulator) a tool for studying the impact of trading restrictions on price formation. Second, we study a leader-follower setting in which a regulator (the leader) sets the trading price by optimizing first its own objective, such as balancing social welfare against a target traded volume or a fairness objective such as Gini-type disparity measure across farmers' profitability, while farmers (the `followers') respond via pro-rata trading. We further compare the proposed pro-rata approach to a family of asymmetric rationing schemes (seniority-based, excess-based, uniform, and mixed pro-rata rules) that trade off proportional fairness against protections for small or senior water-rights holders. Throughout, we illustrate the theoretical results with a numerical case study calibrated to a stylized four-farmer groundwater market.
Read the AI summary, key takeaways and discussion on WOBR Quant Research.