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Hedges and Trees: Incorporating Fire Risk into Optimal Decisions in Forestry Using a No-Arbitrage Approach

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  • Insley, Margaret
  • Lei, Manle

Abstract

This paper investigates the impact of including the risk of fire in an optimal tree harvesting model at the stand level, assuming timber prices follow a mean-reverting stochastic process. The relevant partial differential equation is derived under different assumptions about hedging the risk of fire. The assumption that fire risk is fully diversifiable is contrasted with the assumption that it can be hedged with another asset. It is conjectured that the risk-neutral probability of fire exceeds the historical probability of fire, which will affect forest land valuation. An empirical example is presented for two different silvicultural regimes.

Suggested Citation

  • Insley, Margaret & Lei, Manle, 2007. "Hedges and Trees: Incorporating Fire Risk into Optimal Decisions in Forestry Using a No-Arbitrage Approach," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 32(3), pages 1-23, December.
    • Handle: RePEc:ags:jlaare:7084
    DOI: 10.22004/ag.econ.7084
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    Cited by:

    1. Cantegril, Pierre & Paradis, Gregory & LeBel, Luc & Raulier, Frédéric, 2019. "Bioenergy production to improve value-creation potential of strategic forest management plans in mixed-wood forests of Eastern Canada," Applied Energy, Elsevier, vol. 247(C), pages 171-181.
    2. 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.
    3. 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.
    4. 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.
    5. Work, J. & Qiu, F. & Luckert, M.K., 2016. "Examining hardwood pulp and ethanol prices for improved poplar plantations in Canada," Forest Policy and Economics, Elsevier, vol. 70(C), pages 9-15.
    6. C. E. Dangerfield & A. E. Whalley & N. Hanley & C. A. Gilligan, 2018. "What a Difference a Stochastic Process Makes: Epidemiological-Based Real Options Models of Optimal Treatment of Disease," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 70(3), pages 691-711, July.
    7. 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.
    8. Aghakazemjourabbaf, Sara & Insley, Margaret, 2021. "Leaving your tailings behind: Environmental bonds, bankruptcy and waste cleanup," Resource and Energy Economics, Elsevier, vol. 65(C).
    9. Christian S. L. Crowley & Arun S. Malik & Gregory S. Amacher & Robert G. Haight, 2009. "Adjacency Externalities and Forest Fire Prevention," Land Economics, University of Wisconsin Press, vol. 85(1), pages 162-185.

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