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The Impact of Stochastic Convenience Yield on Long-term Forestry Investment Decisions


  • Shan Chen
  • Margaret Insley

    (Department of Economics, University of Waterloo)

  • Tony Wirjanto

    (School of Accounting & Finance and the Department of Statistics & Actuarial Science, University of Waterloo)


This paper investigates whether convenience yield is an important factor in determining optimal decisions for a forestry investment. The Kalman filter method is used to estimate three different models of lumber prices: a mean reverting model, a simple geometric Brownian motion and the two-factor price model due to Schwartz (1997). In the latter model there are two correlated stochastic factors: spot price and convenience yield. The two-factor model is shown to provide a reasonable fit of the term structure of lumber futures prices. The impact of convenience yield on a forestry investment decision is examined using the Schwartz (1997) long-term model which transforms the two-factor price model into a single factor model with a composite price. Using the long-term model an optimal harvesting problem is analyzed, which requires the numerical solution of an impulse control problem formulated as a Hamilton-Jacobi-Bellman Variational Inequality. We compare the results for the long-term model to those from single-factor mean reverting and geometric Brownian motion models. The inclusion of convenience yield through the long-term model is found to have a significant impact on land value and optimal harvesting decisions.

Suggested Citation

  • Shan Chen & Margaret Insley & Tony Wirjanto, 2011. "The Impact of Stochastic Convenience Yield on Long-term Forestry Investment Decisions," Working Papers 1101, University of Waterloo, Department of Economics, revised Jan 2011.
  • Handle: RePEc:wat:wpaper:1101

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    4. David A. Harpman, 1999. "Assessing the Short-Run Economic Cost of Environmental Constraints on Hydropower Operations at Glen Canyon Dam," Land Economics, University of Wisconsin Press, vol. 75(3), pages 390-401.
    5. Brian K. Edwards & Silvio J. Flaim & Richard E. Howitt, 1999. "Optimal Provision of Hydroelectric Power under Environmental and Regulatory Constraints," Land Economics, University of Wisconsin Press, vol. 75(2), pages 267-283.
    6. Daniel D. Huppert, 1999. "Snake River Salmon Recovery: Quantifying The Costs," Contemporary Economic Policy, Western Economic Association International, vol. 17(4), pages 476-491, October.
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