Adjusting to Climate Change: Implications of Increased Variability and Asymmetric Adjustment Costs for Investment in Water Reserves

In this paper we study the determination of optimal water storage capacity in a region, taking into account that the supply of the resource, the flow into the reserve, is uncertain, that a measure of the uncertainty, the variance, is likely to increase with climate change, that building capacity is costly, and that the development of water resources may entail alsoenvironmental costs. We find that water storage capacity in the long run ispositivelyrelated to increases in uncertainty if the marginal benefit of water withdrawal isconvexand that, for the case of costly reversibility of investment, a range of inaction for investment appears, and the stability of water storage capacity with respect to changes in variance increases.