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

57 Pages Posted: 24 Jun 2018

See all articles by Shan Chen

Shan Chen

University of Waterloo - Department of Economics

Margaret C. Insley

University of Waterloo - Department of Economics

Tony S. Wirjanto

University of Waterloo - School of Accounting and Finance; University of Waterloo, Department of Statistics & Actuarial Science

Date Written: August 3, 2012

Abstract

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 a Hamilton-Jacobi-Bellman equation. 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.

Keywords: optimal tree harvesting, forestry, stochastic convenience yield

JEL Classification: Q23, D81

Suggested Citation

Chen, Shan and Insley, Margaret C. and Wirjanto, Tony S., The Impact of Stochastic Convenience Yield on Long-Term Forestry Investment Decisions (August 3, 2012). Available at SSRN: https://ssrn.com/abstract=3192599 or http://dx.doi.org/10.2139/ssrn.3192599

Shan Chen

University of Waterloo - Department of Economics ( email )

Waterloo, Ontario

Margaret C. Insley (Contact Author)

University of Waterloo - Department of Economics ( email )

200 University Avenue, West
Waterloo, Ontario N2L 3G1
Canada
+1 519-888-4567, ext. 38918 (Phone)

HOME PAGE: http://economics.uwaterloo.ca/margaret-insley

Tony S. Wirjanto

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)

HOME PAGE: http://https://uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

University of Waterloo, Department of Statistics & Actuarial Science ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)
519-746-1875 (Fax)

HOME PAGE: http://math.uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

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