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Rural Investment and the Cost of Income Uncertainty

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  • T Heikkinen

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  • K Pietola

Abstract

This paper studies optimal investment decision in agriculture under diminishing income expectations. The goal is to study the cost of income uncertainty and its implications to the efficiency of investment subsidies. Investment decision is modelled as a Markov decision process, extended to account for risk. Applying a stochastic programming approach, the cost of imperfect information is evaluated as the difference between the profitability of investment under stable income and under uncertain income. Computational experiments demonstrate that the cost of imperfect information can be high, deteriorating the efficiency of investment subsidies. Also, examples suggest that the optimal timing of the investment can be sensitive to risk.

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File URL: http://www-sre.wu-wien.ac.at/ersa/ersaconfs/ersa06/papers/51.pdf
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Bibliographic Info

Paper provided by European Regional Science Association in its series ERSA conference papers with number ersa06p51.

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Date of creation: Aug 2006
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Handle: RePEc:wiw:wiwrsa:ersa06p51

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  1. Carl Johan Lagerkvist, 2005. "Agricultural policy uncertainty and farm level adjustments--the case of direct payments and incentives for farmland investment," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 32(1), pages 1-23, March.
  2. Hong Bo & Robert Lensin, 2005. "Is the Investment-Uncertainty Relationship Nonlinear? An Empirical Analysis for the Netherlands," Economica, London School of Economics and Political Science, vol. 72(286), pages 307-331, 05.
  3. Luis Alvarez & Rune Stenbacka, 2003. "Optimal risk adoption: a real options approach," Economic Theory, Springer, vol. 23(1), pages 123-147, December.
  4. Amegbeto, Koffi N. & Featherstone, Allen M., 1992. "Risk Costs And The Choice Of Market Return Index," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 17(01), July.
  5. Keith C. Knapp & Lars J. Olson, 1996. "Dynamic Resource Management: Intertemporal Substitution and Risk Aversion," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(4), pages 1004-1014.
  6. Keswani, Aneel & Shackleton, Mark B., 2006. "How real option disinvestment flexibility augments project NPV," European Journal of Operational Research, Elsevier, vol. 168(1), pages 240-252, January.
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