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Real options in harvesting decision on publicly owned forest lands

Author

Listed:
  • Margaret Insley

    (Department of Economics, University of Waterloo)

  • Kimberly Rollins

    (Department of Resource Economics, University of Nevada)

Abstract

This paper extends the literature on optimal tree harvesting assuming stochastic prices. With volatile prices, the value of a stand of trees is increased when harvesting dates are flexible, depending on wood volume and product prices of the day. Flexibility adds value because a forest owner can delay harvesting when prices are depressed, or can harvest earlier than planned if there is a uptick in prices. The stand owner thus has a natural hedge against price volatility. Regulatory policy in some jurisdictions has reduced the flexibility of firms harvesting on public lands by imposing allowable cut restrictions. This paper develops a two factor real options model of the harvesting decision over infinite rotations with mean reverting stochastic prices. The model is used to examine a proposed investment in intensive forest management in Ontario's boreal forests. The value of a representative stand in the Romeo Malette forest is estimated assuming complete harvesting flexibility. This value is then compared to the value when regulations dictate a window of time during which harvesting must occur.

Suggested Citation

  • Margaret Insley & Kimberly Rollins, 2002. "Real options in harvesting decision on publicly owned forest lands," Working Papers 02009, University of Waterloo, Department of Economics, revised Jul 2003.
    • Handle: RePEc:wat:wpaper:02009
    as

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    File URL: https://uwaterloo.ca/economics/sites/ca.economics/files/uploads/files/Real%20options%20in%20harvesting%20decision%20on%20publicly%20owned%20forest%20lands.pdf
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    References listed on IDEAS

    as
    1. Kenneth J. Arrow & Anthony C. Fisher, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," Palgrave Macmillan Books, in: Chennat Gopalakrishnan (ed.), Classic Papers in Natural Resource Economics, chapter 4, pages 76-84, Palgrave Macmillan.
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    More about this item

    Keywords

    optimal harvesting; real options; allowable cut restrictions; intensive forest management; Markov decision process; linear complementarity problem;
    All these keywords.

    JEL classification:

    • Q25 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Water
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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