In the Rio Grande Basin, water is over-appropriated, and demands for water grow while supplies are constrained by drought and climate change. The Basin is currently in its seventh year of drought, and reservoirs are at historically low levels. Agricultural and municipal river diversions have been sharply curtailed; low flows threaten endangered species. A central policy challenge is the design and implementation of plans that allocate the Basin's water supplies efficiently, fairly, and sustainably. Such plans are complicated by the demands of existing water users, potential new users, three state governments, and two sovereign nations. These challenges are addressed by designing and developing an integrated basin-wide nonlinear programming model to optimize water allocations and use levels for the Basin. The model permits a quantitative testing and analysis of whether institutional adjustments can limit damages caused by drought. It identifies changes in water uses and allocations that result from those adjustments. Compared to existing rules governing the Basin's water use, future drought damages could be reduced by one-fifth to one-third per year from intrastate and interstate water markets coupled with marginal cost pricing, respectively, that permit water transfers across jurisdictions. Results show hydrologic and economic tradeoffs among water uses, regions, and drought control programs.