Intertemporal-10-28 - Estimating Intertemporal Preferences...

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Estimating Intertemporal Preferences for Natural Resource Allocation Richard E. Howitt a , Siwa Msangi a , Arnaud Reynaud b , and Keith C. Knapp c Abstract In this paper we show how the degree of risk aversion, discounting, and preference for intertemporal substitution for a natural resource manager can be structurally estimated within a recursive utility framework. We focus on the management of Oroville Reservoir, in Northern California, and test the data to see if they are more consistent with a recursive utility model specification than one with standard time-additive separability, and estimate the implied degree of risk aversion. The results show that the data on dam storage and releases are consistent with a risk-averse manager with recursive preferences, and that preferences are stationary over the observed period. The data also rejects time-additive separability, whether specified with or without risk-aversion, such as the standard CRRA utility model. The improvement in model fit when recursive preferences are used is notable. Contact author Richard Howitt Department of Agricultural and Resource Economics, University of California Davis, Ca 95616 Phone 530 752 1521 fax 530 752 5614 Email [email protected] a Department of Agricultural and Resource Economics, University of California at Davis. b LERNA-INRA, University of Social Sciences Toulouse. c Department of Environmental Sciences, University of California at Riverside. The authors gratefull acknowledge support from a risk management grant from USDA-ERS that made this study possible.
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2 Introduction Natural resource management problems are typically stochastic and dynamic in nature, by virtue of the characteristics of the underlying physical or biological processes that govern the evolution of the resource. This has been the reason for a number of empirical applications of Dynamic Programming within the natural resource literature, as chronicled by Williams (1989). However, the tendency of researchers to use risk-neutral expected net present value objective functions when modeling natural resource problems has caused policy-makers to be somewhat skeptical of the real-world relevance of resource economics analysis 1 . Given the uncertainty facing the decision-maker in each period of the planning horizon, due to the realization of stochastic shocks, we would expect risk-aversion and intertemporal substitution to feature prominently in the characterization of intertemporal preferences. While a number of authors have incorporated risk-aversion into analytical and numerical models in the economic literature (Knapp and Olson, 1996; Krautkramer et al., 1992), few have actually tried to estimate the degree to which it enters into the decision-makers objective criterion, and none of those papers consider natural resource management problems. Most of the resource literature has imposed severe restrictions on the preferences for intertemporal substitution by adopting a time-additive separable formulation of the objective function.
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Intertemporal-10-28 - Estimating Intertemporal Preferences...

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