Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem

Shan Chen and Margaret Insley

Journal of Economic Dynamics and Control, 2012, vol. 36, issue 2, 201-219

Abstract: This paper investigates whether a regime switching model of stochastic lumber prices is better for the analysis of optimal harvesting problems in forestry than a more traditional single regime model. Prices of lumber derivatives are used to calibrate a regime switching model, with each of two regimes characterized by a different mean reverting process. A single regime, mean reverting process is also calibrated. The value of a representative stand of trees and optimal harvesting prices are determined by specifying a Hamilton–Jacobi–Bellman Variational Inequality, which is solved for both pricing models using a implicit finite difference approach. The regime switching model is found to more closely match the behavior of futures prices than the single regime model. In addition, analysis of a tree harvesting problem indicates significant differences in terms of land value and optimal harvest thresholds between the regime switching and single regime models.

Keywords: Regime switching; Optimal tree harvesting; Mean reverting price; Lumber derivatives prices; Hamilton–Jacobi–Bellman variational inequality (search for similar items in EconPapers)
JEL-codes: C61 C63 D81 Q23 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (14)

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Related works:
Working Paper: Regime Switching in Stochastic Models of Commodity Prices: An Application to an Optimal Tree Harvesting Problem (2010)
Working Paper: Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:36:y:2012:i:2:p:201-219

DOI: 10.1016/j.jedc.2011.08.010

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