IDEAS home Printed from https://ideas.repec.org/p/ces/ceswps/_1285.html
   My bibliography  Save this paper

Does Risk Aversion Accelerate Optimal Forest Rotation under Uncertainty?

Author

Listed:
  • Luis H. R. Alvarez
  • Erkki Koskela

Abstract

We use a Wicksellian single rotation framework to analyze the impact of the intertemporally fluctuating and stochastic mean-reverting interest rate process on the optimal harvesting threshold and thereby the expected length of the rotation period, when forest value is also stochastic following geometric Brownian motion and landowners are risk-averse. We provide an explicit solution for the two-dimensional path-dependent rotation problem and demonstrate that higher interest rate volatility increases, while higher risk aversion decreases the optimal harvesting threshold. Moreover, under risk aversion increased forest value volatility decreases the optimal harvesting threshold, while it has no effect under risk neutrality. Numerical illustrations indicate that higher interest rate volatility will raise the expected rotation period at an increasing rate, while higher forest value volatility will decrease its sensitivity under risk aversion.

Suggested Citation

  • Luis H. R. Alvarez & Erkki Koskela, 2004. "Does Risk Aversion Accelerate Optimal Forest Rotation under Uncertainty?," CESifo Working Paper Series 1285, CESifo.
    • Handle: RePEc:ces:ceswps:_1285
    as

    Download full text from publisher

    File URL: https://www.cesifo.org/DocDL/cesifo1_wp1285.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. 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.
    2. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
    3. Chang, Fwu-Ranq, 2005. "On the elasticities of harvesting rules," Journal of Economic Dynamics and Control, Elsevier, vol. 29(3), pages 469-485, March.
    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. Willassen, Yngve, 1998. "The stochastic rotation problem: A generalization of Faustmann's formula to stochastic forest growth," Journal of Economic Dynamics and Control, Elsevier, vol. 22(4), pages 573-596, April.
    6. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 5, pages 129-164, World Scientific Publishing Co. Pte. Ltd..
    7. 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.
    8. 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.
    9. 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.
    10. Luis H. R. Alvarez, 2001. "Reward functionals, salvage values, and optimal stopping," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 54(2), pages 315-337, December.
    11. 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.
    12. 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.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. 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.
    2. 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), pages 1-14, December.
    3. 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.
    4. 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.
    5. Ben Abdallah, Skander & Lasserre, Pierre, 2016. "Asset retirement with infinitely repeated alternative replacements: Harvest age and species choice in forestry," Journal of Economic Dynamics and Control, Elsevier, vol. 70(C), pages 144-164.
    6. Alvarez, Luis H.R. & Koskela, Erkki, 2007. "Optimal harvesting under resource stock and price uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 31(7), pages 2461-2485, July.
    7. Luis H. R. Alvarez & Erkki Koskela, 2003. "On the Tree-Cutting Problem under Interest Rate and Forest Value Uncertainty," CESifo Working Paper Series 870, CESifo.
    8. Tahvonen, Olli & Suominen, Antti & Malo, Pekka & Viitasaari, Lauri & Parkatti, Vesa-Pekka, 2022. "Optimizing high-dimensional stochastic forestry via reinforcement learning," Journal of Economic Dynamics and Control, Elsevier, vol. 145(C).
    9. 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.
    10. Newman, D.H., 2002. "Forestry's golden rule and the development of the optimal forest rotation literature," Journal of Forest Economics, Elsevier, vol. 8(1), pages 5-27.
    11. Chen, Shan & Insley, Margaret, 2012. "Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem," Journal of Economic Dynamics and Control, Elsevier, vol. 36(2), pages 201-219.
    12. Insley, M.C. & Wirjanto, T.S., 2010. "Contrasting two approaches in real options valuation: Contingent claims versus dynamic programming," Journal of Forest Economics, Elsevier, vol. 16(2), pages 157-176, April.
    13. Tee, James & Scarpa, Riccardo & Marsh, Dan & Guthrie, Graeme, 2012. "Valuation of Carbon Forestry and the New Zealand Emissions Trading Scheme: A Real Options Approach Using the Binomial Tree Method," 2012 Conference, August 18-24, 2012, Foz do Iguacu, Brazil 123665, International Association of Agricultural Economists.
    14. Leon-Santana, Miguel & Hernandez, Juan M., 2008. "Optimum management and environmental protection in the aquaculture industry," Ecological Economics, Elsevier, vol. 64(4), pages 849-857, February.
    15. 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.
    16. Esther W. Mezey & Jon M. Conrad, 2010. "Real Options in Resource Economics," Annual Review of Resource Economics, Annual Reviews, vol. 2(1), pages 33-52, October.
    17. Tee, James & Scarpa, Riccardo & Marsh, Dan & Guthrie, Graeme, 2010. "A Binomial Tree Approach to Valuing Fixed Rotation Forests and Flexible Rotation Forests Under a Mean Reverting Timber Price Process," 2010 Conference, August 26-27, 2010, Nelson, New Zealand 96836, New Zealand Agricultural and Resource Economics Society.
    18. Hildebrandt, Patrick & Knoke, Thomas, 2011. "Investment decisions under uncertainty--A methodological review on forest science studies," Forest Policy and Economics, Elsevier, vol. 13(1), pages 1-15, January.
    19. Yu, Zhihan & Ning, Zhuo & Chang, Wei-Yew & Chang, Sun Joseph & Yang, Hongqiang, 2023. "Optimal harvest decisions for the management of carbon sequestration forests under price uncertainty and risk preferences," Forest Policy and Economics, Elsevier, vol. 151(C).
    20. James Tee & Riccardo Scarpa & Dan Marsh & Graeme Guthrie, 2014. "Forest Valuation under the New Zealand Emissions Trading Scheme: A Real Options Binomial Tree with Stochastic Carbon and Timber Prices," Land Economics, University of Wisconsin Press, vol. 90(1), pages 44-60.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ces:ceswps:_1285. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Klaus Wohlrabe (email available below). General contact details of provider: https://edirc.repec.org/data/cesifde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.