Application of modern financial portfolio theory to water resource portfolios

Modern portfolio theory developed for financial markets has application to water resource portfolios. It can help make decisions on how to optimally meet future water needs. By explicitly considering volatility and correlations among water resource alternatives, rational resource combinations can be selected. It enables water planners to decide how much to invest in traditional ways to meet water needs such as surface and groundwater supplies and to decide how much to invest in non-traditional, more expensive supplies such as recycling, conservation, and desalination. It enables explicit risk reduction of systematic risks due to the hydrologic cycle such as drought, and non-systematic risks such as water quality, climate, and energy. This paper describes a qualitative application of modern portfolio theory to water resources. Quantitative application will require the development of additional data.