Regime Switching in Stochastic Models of Commodity Prices: An Application to an Optimal Tree Harvesting Problem

Shan Chen and Margaret Insley
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Shan Chen: Department of Economics, University of Waterloo

No 1016, Working Papers from University of Waterloo, Department of Economics

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 fully implicit finite difference approach. The regime switching model is found to more closely match the behaviour 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.

JEL-codes: C61 C63 D81 Q23 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2010-07, Revised 2010-07
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Related works:
Journal Article: Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem (2012)
Working Paper: Regime switching in stochastic models of commodity prices: An application to an optimal tree harvesting problem (2008)
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