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On Forest Rotation under Interest Rate Variability

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  • Alvarez, Luis H R
  • Koskela, Erkki

Abstract

The current literature on optimal forest rotation makes the unrealistic assumption of a constant interest rate although harvesting decisions of forest stands are typically subject to relatively long time horizons. We apply the single rotation framework to extend the existing studies to cover the unexplored case of variable interest rate. We show that even in the deterministic case if the current interest rate deviates from its long-run steady state, interest rate variability may change the rotation age significantly when compared with the constant discounting case. Further, and importantly, allowing for interest rate uncertainty as a mean reverting process and forest value as a geometric Brownian motion, we can provide an explicit solution for the two dimensional path-dependent optimal stopping problem. Increased interest rate volatility is shown to lengthen the optimal rotation period. Numerical calculations show that interest rate volatility has a large quantitative importance. Copyright 2003 by Kluwer Academic Publishers

Suggested Citation

  • Alvarez, Luis H R & Koskela, Erkki, 2003. "On Forest Rotation under Interest Rate Variability," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 10(4), pages 489-503, August.
  • Handle: RePEc:kap:itaxpf:v:10:y:2003:i:4:p:489-503
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    References listed on IDEAS

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    1. Insley, Margaret, 2002. "A Real Options Approach to the Valuation of a Forestry Investment," Journal of Environmental Economics and Management, Elsevier, vol. 44(3), pages 471-492, November.
    2. Alvarez, Luis H. R. & Koskela, Erkki, 2005. "Wicksellian theory of forest rotation under interest rate variability," Journal of Economic Dynamics and Control, Elsevier, vol. 29(3), pages 529-545, March.
    3. Reed, William J & Clarke, Harry R, 1990. "Harvest Decisions and Asset Valuation for Biological Resources Exhibiting Size-Dependent Stochastic Growth," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(1), pages 147-169, February.
    4. Samuelson, Paul A, 1976. "Economics of Forestry in an Evolving Society," Economic Inquiry, Western Economic Association International, vol. 14(4), pages 466-492, December.
    5. Hartman, Richard, 1976. "The Harvesting Decision When a Standing Forest Has Value," Economic Inquiry, Western Economic Association International, vol. 14(1), pages 52-58, March.
    6. Markku Ollikainen & Erkki Koskela, 2001. "Optimal Private and Public Harvesting under Spatial and Temporal Interdependence," CESifo Working Paper Series 452, CESifo Group Munich.
    7. Reed, William J., 1984. "The effects of the risk of fire on the optimal rotation of a forest," Journal of Environmental Economics and Management, Elsevier, vol. 11(2), pages 180-190, June.
    8. Tahvonen, Olli & Salo, Seppo & Kuuluvainen, Jari, 2001. "Optimal forest rotation and land values under a borrowing constraint," Journal of Economic Dynamics and Control, Elsevier, vol. 25(10), pages 1595-1627, October.
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    Cited by:

    1. Zhou, Mo & Buongiorno, Joseph, 2011. "Effects of stochastic interest rates in decision making under risk: A Markov decision process model for forest management," Forest Policy and Economics, Elsevier, vol. 13(5), pages 402-410, June.
    2. Brunette, Marielle & Couture, Stéphane & Langlais, Eric, 2009. "Amenities and Risk in Forest Management," MPRA Paper 14743, University Library of Munich, Germany.
    3. Luis Alvarez, 2010. "Irreversible capital accumulation under interest rate uncertainty," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 72(2), pages 249-271, October.
    4. Luis H.R. Alvarez E., 2006. "Irreversible Investment, Incremental Capital Accumulation, and Price Uncertainty," Discussion Papers 4, Aboa Centre for Economics.
    5. repec:spr:compst:v:72:y:2010:i:2:p:249-271 is not listed on IDEAS
    6. Julia Touza & Charles Perrings & María Chas Amil, 2010. "Harvest Decisions and Spatial Landscape Attributes: The Case of Galician Communal Forests," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 46(1), pages 75-91, May.
    7. Thang, Tran Cong & Burton, Michael P. & Brennan, Donna C., 2009. "Optimal replanting and cutting rule for coffee farmers in Vietnam," 2009 Conference (53rd), February 11-13, 2009, Cairns, Australia 47638, Australian Agricultural and Resource Economics Society.
    8. Creamer, Selmin F. & Genz, Alan & Blatner, Keith A., 2012. "The Effect of Fire Risk on the Critical Harvesting Times for Pacific Northwest Douglas-Fir When Carbon Price Is Stochastic," Agricultural and Resource Economics Review, Northeastern Agricultural and Resource Economics Association, vol. 41(3), December.
    9. Olivier Damette & Philippe Delacote, 2009. "The environmental resource curse hypothesis: the forest case," Working Papers - Cahiers du LEF 2009-04, Laboratoire d'Economie Forestiere, AgroParisTech-INRA.
    10. Alvarez, Luis H.R. & Koskela, Erkki, 2006. "Does risk aversion accelerate optimal forest rotation under uncertainty?," Journal of Forest Economics, Elsevier, vol. 12(3), pages 171-184, December.
    11. Alvarez, Luis H.R. & Koskela, Erkki, 2007. "Taxation and rotation age under stochastic forest stand value," Journal of Environmental Economics and Management, Elsevier, vol. 54(1), pages 113-127, July.
    12. Sylvain Caurla & Philippe Delacote & Franck Lecocq & Ahmed Barkaoui, 2009. "Fuelwood consumption, restrictions about resource availability and public policies: impacts on the French forest sector," Working Papers - Cahiers du LEF 2009-03, Laboratoire d'Economie Forestiere, AgroParisTech-INRA.
    13. Buongiorno, Joseph & Zhou, Mo, 2011. "Further generalization of Faustmann's formula for stochastic interest rates," Journal of Forest Economics, Elsevier, vol. 17(3), pages 248-257, August.
    14. Shackleton, Mark B. & Sødal, Sigbjørn, 2010. "Harvesting and recovery decisions under uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 34(12), pages 2533-2546, December.

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