Regime Switching in Stochastic Models of Commodity Prices: An Application to an Optimal Tree Harvesting Problem
AbstractThis paper investigates whether a regime switching model of stochastic lumber prices is better for the analysis of optimal harvesting problems in forestry than a more traditional single regime model. Prices of lumber derivatives are used to calibrate a regime switching model, with each of two regimes characterized by a different mean reverting process. A single regime, mean reverting process is also calibrated. The value of a representative stand of trees and optimal harvesting prices are determined by specifying a Hamilton-Jacobi-Bellman Variational Inequality, which is solved for both pricing models using a fully implicit finite difference approach. The regime switching model is found to more closely match the behaviour of futures prices than the single regime model. In addition, analysis of a tree harvesting problem indicates significant differences in terms of land value and optimal harvest thresholds between the regime switching and single regime models.
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Bibliographic InfoPaper provided by University of Waterloo, Department of Economics in its series Working Papers with number 1016.
Length: 52 pages
Date of creation: Jul 2010
Date of revision: Jul 2010
Other versions of this item:
- Chen, Shan & Insley, Margaret, 2012. "Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem," Journal of Economic Dynamics and Control, Elsevier, vol. 36(2), pages 201-219.
- Shan Chen & Margaret Insley, 2008. "Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem," Working Papers 08003, University of Waterloo, Department of Economics.
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- Q23 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Forestry
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-02-05 (All new papers)
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