Investment and the dynamic cost of income uncertainty: The case of diminishing expectations in agriculture |
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Authors: | T Heikkinen K Pietola |
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Institution: | 1. MTT Economic Research, Luutnantintie 13, 00410 Helsinki, Finland;2. Department of Computer Science, the University of Helsinki, Finland |
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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. The investment decision of a representative farm 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 model can be applied to agricultural policy planning. In the case study, the investment decision is sensitive to risk. |
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Keywords: | Investment analysis Real options Stochastic programming OR in agriculture |
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