Chile is illustrative of a transition from command and control to market based water management policy, where economic policy incentives (EPI) play a significant role in water rights allocations. The enabling factor that allowed for the implementation of water rights markets in Chile was Chile’s tradition and culture, dating back to colonial times, of managing water resources with water rights. The Chilean Water Code of 1981 established that water rights are transferable in order to facilitate markets as an allocation mechanism. The framers of the 1981 Water Code sought to achieve efficient water allocations with this EPI. The existence of water markets has been documented. A key conclusion of these studies is that water markets are more prevalent in areas of water scarcity. They are driven by demand from relatively high-valued water uses and facilitated by low transactions costs in those valleys where Water User Associations and infrastructure present assist the transfer of water. In the absence of these conditions trading has been rare and water markets have not become institutionalized. A major challenge of water rights markets in Chile is how to ensure optimal water use without compromising the sustainability of rivers and aquifers. The implementation of this EPI did not establish new institutions; however, it significantly modified their existing powers. Nevertheless, in order for it to deliver its full potential as an efficient allocation mechanism, Chile requires an institutional reform in order to respond to the country’s actual water challenges.