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Does Risk Aversion Accelerate Optimal Forest Rotation under Uncertainty?

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Author Info
Luis H. R. Alvarez ()
Erkki Koskela ()
Abstract

We use a Wicksellian single rotation framework to analyze the impact of the intertemporally fluctuating and stochastic mean-reverting interest rate process on the optimal harvesting threshold and thereby the expected length of the rotation period, when forest value is also stochastic following geometric Brownian motion and landowners are risk-averse. We provide an explicit solution for the two-dimensional path-dependent rotation problem and demonstrate that higher interest rate volatility increases, while higher risk aversion decreases the optimal harvesting threshold. Moreover, under risk aversion increased forest value volatility decreases the optimal harvesting threshold, while it has no effect under risk neutrality. Numerical illustrations indicate that higher interest rate volatility will raise the expected rotation period at an increasing rate, while higher forest value volatility will decrease its sensitivity under risk aversion.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 1285.

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Date of creation: 2004
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Handle: RePEc:ces:ceswps:_1285

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Related research
Keywords: forest rotation; risk aversion; stochastic interest rates; optimal stopping;

Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
Q23 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Forestry

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  1. Alvarez, Luis H R & Koskela, Erkki, 2003. "On Forest Rotation under Interest Rate Variability," International Tax and Public Finance, Springer, vol. 10(4), pages 489-503, August. [Downloadable!] (restricted)
  2. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March. [Downloadable!] (restricted)
  3. Insley, Margaret, 2002. "A Real Options Approach to the Valuation of a Forestry Investment," Journal of Environmental Economics and Management, Elsevier, vol. 44(3), pages 471-492, November. [Downloadable!] (restricted)
  4. Luis H.R. Alvarez & Erkki Koskela, 2003. "On Forest Rotation Under Interest Rate Variability," Discussion Papers 840, The Research Institute of the Finnish Economy. [Downloadable!]
  5. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December. [Downloadable!] (restricted)
    Other versions:
  6. Reed, William J & Clarke, Harry R, 1990. "Harvest Decisions and Asset Valuation for Biological Resources Exhibiting Size-Dependent Stochastic Growth," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(1), pages 147-69, February. [Downloadable!] (restricted)
  7. Chang, Fwu-Ranq, 2005. "On the elasticities of harvesting rules," Journal of Economic Dynamics and Control, Elsevier, vol. 29(3), pages 469-485, March. [Downloadable!] (restricted)
    Other versions:
  8. Samuelson, Paul A, 1976. "Economics of Forestry in an Evolving Society," Economic Inquiry, Oxford University Press, vol. 14(4), pages 466-92, December.
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This page was last updated on 2009-12-14.

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