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Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem

  • Chen, Shan
  • Insley, Margaret

This 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 implicit finite difference approach. The regime switching model is found to more closely match the behavior 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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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 36 (2012)
Issue (Month): 2 ()
Pages: 201-219

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Handle: RePEc:eee:dyncon:v:36:y:2012:i:2:p:201-219
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  17. Morck, Randall & Schwartz, Eduardo & Stangeland, David, 1989. "The Valuation of Forestry Resources under Stochastic Prices and Inventories," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(04), pages 473-487, December.
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