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Rural Investment and the Cost of Income Uncertainty

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  • T Heikkinen
  • K Pietola

Abstract

This paper studies optimal investment decision in agriculture under diminishing income expectations. The goal is to study the cost of income uncertainty and its implications to the efficiency of investment subsidies. Investment decision is modelled as a Markov decision process, extended to account for risk. Applying a stochastic programming approach, the cost of imperfect information is evaluated as the difference between the profitability of investment under stable income and under uncertain income. Computational experiments demonstrate that the cost of imperfect information can be high, deteriorating the efficiency of investment subsidies. Also, examples suggest that the optimal timing of the investment can be sensitive to risk.

Suggested Citation

  • T Heikkinen & K Pietola, 2006. "Rural Investment and the Cost of Income Uncertainty," ERSA conference papers ersa06p51, European Regional Science Association.
    • Handle: RePEc:wiw:wiwrsa:ersa06p51
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    File URL: https://www-sre.wu.ac.at/ersa/ersaconfs/ersa06/papers/51.pdf
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    References listed on IDEAS

    as
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    2. repec:bla:econom:v:72:y:2005:i:286:p:307-331 is not listed on IDEAS
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    4. Carl Johan Lagerkvist, 2005. "Agricultural policy uncertainty and farm level adjustments--the case of direct payments and incentives for farmland investment," European Review of Agricultural Economics, Oxford University Press and the European Agricultural and Applied Economics Publications Foundation, vol. 32(1), pages 1-23, March.
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