Estimation of drought characteristics such as probabilities and return periods of droughts of various lengths is of major importance in drought forecast and management and in solving water resources problems related to water quality and navigation. This study aims at applying first-and second-order Markov chain models to dry and wet periods of annual streamflow series to reproduce the stochastic structure of hydrological droughts. Statistical evaluation of drought duration and intensity is usually carried out using runs analysis. First-order Markov chain model (MC1) for dry and wet periods is not adequate when autocorrelation of the original hydrological series is high. A second-order Markov chain model (MC2) is proposed to estimate the probabilities and return periods of droughts. Results of these models are compared with those of a simulation study assuming a lag-1 autoregressive [AR(1)] process widely used to model annual streamflows. Probability distribution and return periods of droughts of various lengths are estimated and compared with the results of MC1 and MC2 models using efficacy evaluation statistics. It is found that the MC2 model in general gives results that are in better agreement with simulation results as compared with the MC1 model. Skewness is found to have little effect on return periods except when autocorrelation is very high. MC1 and MC2 models are applied to droughts observed in some annual streamflow series, with the result that the MC2 model has a relatively good agreement considering the limited duration of the records.