Wicksellian Theory of Forest Rotation Under Interest Rate Variability

24 Pages Posted: 29 Nov 2001

See all articles by Luis Hernan Radomiro Alvarez

Luis Hernan Radomiro Alvarez

University of Turku - Turku School of Economics

Erkki Koskela

University of Helsinki - Department of Political and Economic Studies; CESifo (Center for Economic Studies and Ifo Institute); Bank of Finland - Research Department; IZA Institute of Labor Economics

Date Written: November 2001

Abstract

The current literature on optimal forest rotation makes the assumption of constant interest rate. However, the irreversible harvesting decisions of forest stands are typically subject to relatively long time horizons over which interest rates do fluctuate considerably. In this paper we apply the Wicksellian single rotation framework to extend the existing studies to cover the unexplored case of variable interest rate. Given the technical generality of the considered valuation problem, we provide a thorough mathematical characterization of the optimal timing problem and develop new results. We show that even in the deterministic case if the current interest rate deviates from its long-run steady state, interest rate variability changes the rotation age significantly when compared with the constant discounting case. Further, and importantly, allowing for interest rate uncertainty is shown to increase the optimal rotation period when the value of the optimal policy is a convex function of the current interest rate. In line with this finding, we also establish that increased interest rate volatility has a positive impact on the optimal rotation period.

Keywords: Wicksellian Rotation, Variable Interest Rates, Linear Diffusions, Optimal Stopping, Free Boundary Problems

JEL Classification: Q23, G31, C61

Suggested Citation

Radomiro Alvarez E., Luis Hernan and Koskela, Erkki, Wicksellian Theory of Forest Rotation Under Interest Rate Variability (November 2001). CESifo Working Paper Series No. 606. Available at SSRN: https://ssrn.com/abstract=292241

Luis Hernan Radomiro Alvarez E.

University of Turku - Turku School of Economics ( email )

Rehtorinpellonkat 3
FIN-20500 Turku
Finland

Erkki Koskela (Contact Author)

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland
+358 9 191 8894 (Phone)
+358 9 191 8877 (Fax)

HOME PAGE: http://www.cesifo.de/servlet/page?_pageid=56&_dad=portal30&_schema=PORTAL30&pa_id=7298

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Bank of Finland - Research Department ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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