Investment decisions of dairy farmers in south-west Victoria under price and yield uncertainty

This paper uses real-options analysis to examine the investment and disinvestment decisions of dairy farmers in south-west Victoria when there is uncertainty in milk price and yield. By investment and disinvestment we mean purchase and sale of properties rather than investment in the capital stock of properties. Optimal entry and exit thresholds were calculated for four different sizes of dairy farms and compared to the results from a conventional approach. The model identified lower exit and higher entry thresholds than would be indicated by the conventional approach that ignores the uncertainty of prices and yields. Our empirical analysis illustrates how these decisions vary between different farm sizes even with a moderate degree of revenue volatility, a relatively small amount of sunk costs, and changes of other parameters. Our work provides better explanations for some important issues in dairy farm investment, in particular, the advantages that accrue to farmers by delaying decisions to enter or leave industries. The wider range of entry and exit thresholds helps explain the stickiness of adjustment of the dairy industry in the face of volatility of revenue and production.

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 Record created 2017-04-01, last modified 2018-01-22

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