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A Stochastic Dynamic Programming Analysis of Farmland Investment and Financial Management

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  • Heman D. Lohano
  • Robert P. King

Abstract

This paper develops a multiperiod investment portfolio model that includes risky farmland, risky and risk‐free nonfarm assets, and debt financing on farmland in the presence of transaction costs and credit constraints. The model is formulated as a stochastic continuous‐state dynamic programming problem, and is solved numerically for Southwestern Minnesota, USA. Results show that optimal investment decisions are dynamic and take into account the future decisions due to uncertainty, partial irreversibility, and the option to wait. The optimal policy includes ranges of inaction, states where the optimal policy in the current year is to wait. The risk‐averse farmer makes a lower investment in risky farmland reflecting risk‐avoiding behavior. We find that, in addition to risk aversion, the length of the planning horizon affects risk‐avoiding behavior in investment decisions. In contrast to a static model, changes in the riskiness of returns affect optimal investment decisions even when the decision maker is risk neutral. Finally, we find that higher debt financing on farmland is optimal when risky nonfarm assets can be included in the optimal investment portfolio and that the probability of exiting farming increases with the risky nonfarm investment. Dans le présent article, nous avons élaboré un modèle de portefeuille multipériode composé d'actifs agricoles risqués (terres), d'actifs non agricoles risqués et sans risque ainsi que de financement par emprunt de terres comprenant des coûts de transaction et des contraintes de crédit. Le modèle a été formulé comme un problème de programmation dynamique stochastique en temps continu et a été résolu de façon numérique pour le sud‐ouest du Minnesota, aux États‐Unis. Les résultats ont montré que les décisions optimales d'investissement sont dynamiques et qu’elles tiennent compte des décisions futures en raison de l'incertitude, de l'irréversibilité partielle et du choix d'attendre. La politique optimale inclut des plages d'inaction et des situations où la politique optimale de l'année en cours doit attendre. L'agriculteur risquophobe investit peu dans des actifs fonciers risqués ce qui traduit un comportement d'évitement des risques. Nous sommes arrivés à la conclusion que la longueur de l'horizon de planification, en plus de l'aversion pour le risque, influe sur le comportement d'évitement des risques au moment de prendre des décisions d'investissement. Contrairement au modèle statique, les changements dans les risques de rendements influent sur les décisions optimales d'investissement même si le décideur est indifférent au risque. Finalement, nous avons trouvé que le financement par emprunt pour des terres agricoles est optimal lorsqu’il est possible d'inclure des actifs non agricoles risqués dans le portefeuille optimal et que la probabilité de quitter l'agriculture augmente en présence d'investissements non agricoles risqués.

Suggested Citation

  • Heman D. Lohano & Robert P. King, 2009. "A Stochastic Dynamic Programming Analysis of Farmland Investment and Financial Management," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 57(4), pages 575-600, December.
    • Handle: RePEc:bla:canjag:v:57:y:2009:i:4:p:575-600
    DOI: 10.1111/j.1744-7976.2009.01171.x
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    References listed on IDEAS

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    1. Olson, Kent D. & Westman, Lorin L., 1991. "Southeastern Minnesota Farm Business Management Association 1990 Annual Report," Economic Reports 13076, University of Minnesota, Department of Applied Economics.
    2. Scott R. Jeffrey & Vernon R. Eidman, 1991. "The Application of Multivariate Stochastic Dominance Criteria to Agricultural Economic Problems," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 39(2), pages 193-209, July.
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    6. Burt, Oscar R. & Taylor, C. Robert, 1989. "Reduction Of State Variable Dimension In Stochastic Dynamic Optimization Models Which Use Time-Series Data," Western Journal of Agricultural Economics, Western Agricultural Economics Association, vol. 14(2), pages 1-10, December.
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    9. Taff, Steven J., 2008. "Minnesota Farm Real Estate Sales: 1990-2007," Staff Papers 36776, University of Minnesota, Department of Applied Economics.
    10. King, Robert P. & Lohano, Heman D., 2006. "Accuracy of Numerical Solution to Dynamic Programming Models," Staff Papers 14230, University of Minnesota, Department of Applied Economics.
    11. Baker, C.B. & Barry, Peter J. & Lee, Warren F. & Olson, Carl E. & Hochman, Eithan & Rausser, Gordon S. & Kottke, Marvin W., 1977. "Economic Growth of the Agricultural Firm," Western Region Archives 260636, Western Region - Western Extension Directors Association (WEDA).
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    1. James Nolan & Dawn Parker & G. Cornelis Van Kooten & Thomas Berger, 2009. "An Overview of Computational Modeling in Agricultural and Resource Economics," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 57(4), pages 417-429, December.
    2. Browne, Natalie & Kingwell, Ross & Behrendt, Ralph & Eckard, Richard, 2013. "The relative profitability of dairy, sheep, beef and grain farm enterprises in southeast Australia under selected rainfall and price scenarios," Agricultural Systems, Elsevier, vol. 117(C), pages 35-44.

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