On the Tree-Cutting Problem Under Interest Rate and Forest Value Uncertainty

14 Pages Posted: 16 Mar 2003

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: February 2003

Abstract

The current literature on optimal forest rotation makes the unrealistic assumption of constant interest rate though harvesting decisions of forest stands are typically subject to long time horizons. We apply the Wicksellian single rotation framework to cover the unexplored case of variable and stochastic interest rate. By modelling the stochastic interest rate according to the Cox-Ingersoll-Ross model and the forest value as a geometric Brownian motion we provide an explicit solution for the Wicksellian single rotation problem and show that increased interest rate volatility increases the optimal exercise threshold of the irreversible harvesting opportunity and thereby prolongs the optimal rotation period. Numerical illustration indicates that the optimal threshold becomes higher at an increasing rate.

Keywords: Forest Rotation, Optimal Stopping, Stochastic Interest Rates

JEL Classification: Q23, G31, C61

Suggested Citation

Radomiro Alvarez E., Luis Hernan and Koskela, Erkki, On the Tree-Cutting Problem Under Interest Rate and Forest Value Uncertainty (February 2003). CESifo Working Paper Series No. 870. Available at SSRN: https://ssrn.com/abstract=385125

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

Register to save articles to
your library

Register

Paper statistics

Downloads
161
Abstract Views
1,391
rank
183,019
PlumX Metrics