RISK AND THE DISCOUNT RATE IN FORESTRY

One of the most common ways to account for investment risk is to add a risk premium to the risk-free discount rate when computing present va lues of expected revenues which are uncertain. Using certainty-equival ent analysis, we show that the correct risk premium for short-term inv estments can easily be in the commonly used 7-percentage-point range. But for such risk premiums to be appropriate for long-term forestry in vestments, the necessary certainty-equivalent conditions often seem to be unreasonably restrictive. Results suggest that the appropriate ris k premium may decline with lengthening payoff period for many forest i nvestments. Limited empirical data provide tentative support, but more research is needed to resolve the issue. We review policy implication s and suggest areas for further research.