Hedges and Trees: Incorporating Fire Risk into Optimal Decisions in Forestry Using a No-Arbitrage Approach
This paper investigates the impact of including the risk of fire in an optimal tree harvesting model at the stand level, assuming timber prices follow a mean-reverting stochastic process. The relevant partial differential equation is derived under different assumptions about hedging the risk of fire. The assumption that fire risk is fully diversifiable is contrasted with the assumption that it can be hedged with another asset. It is conjectured that the risk-neutral probability of fire exceeds the historical probability of fire, which will affect forest land valuation. An empirical example is presented for two different silvicultural regimes.
Volume (Year): 32 (2007)
Issue (Month): 03 (December)
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- Insley, M.C. & Wirjanto, T.S., 2010.
"Contrasting two approaches in real options valuation: Contingent claims versus dynamic programming,"
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- Margaret Insley & Kimberly Rollins, 2005. "On Solving the Multirotational Timber Harvesting Problem with Stochastic Prices: A Linear Complementarity Formulation," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 87(3), pages 735-755.
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"The Dynamic Behavior of Efficient Timber Prices,"
Staff Paper Series
454, University of Wisconsin, Agricultural and Applied Economics.
- Reed, William J., 1993. "The decision to conserve or harvest old-growth forest," Ecological Economics, Elsevier, vol. 8(1), pages 45-69, August.
- Jonathan Yoder, 2004. "Playing with Fire: Endogenous Risk in Resource Management," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 86(4), pages 933-948.
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