Investment and the Dynamic Cost of Income Uncertainty: the Case of Diminishing Expectations in Agriculture

Tiina Heikkinen and Kyosti Pietola

No 11868, Discussion Papers from MTT Agrifood Research Finland

Abstract: This paper studies optimal investment and the dynamic cost of income uncertainty, applying a stochastic programming approach. The motivation is given by a case study in Finnish agriculture. Investment decision is modelled as a Markov decision process, extended to account for risk. A numerical framework for studying the dynamic uncertainty cost is presented, modifying the classical expected value of perfect information to a dynamic setting. The uncertainty cost depends on the volatility of income; e.g. with stationary income, the dynamic uncertainty cost corresponds to a dynamic option value of postponing investment. The numerical investment model also yields the optimal investment behavior of a representative farm. The model can be applied e.g. in planning investment subsidies for maintaining target investments. In the case study, the investment decision is sensitive to risk.

Keywords: Financial; Economics (search for similar items in EconPapers)
Pages: 20
Date: 2006
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Investment and the dynamic cost of income uncertainty: The case of diminishing expectations in agriculture (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:ags:mttfdp:11868

DOI: 10.22004/ag.econ.11868

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