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What is the relevance of option pricing for forest valuation in New Zealand?

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  • Manley, Bruce
  • Niquidet, Kurt
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    Abstract

    Three different option value approaches are used to estimate the value of a typical New Zealand plantation stand, under the assumption that log prices follow a random walk. Crop values are compared with the Faustmann value, the benchmark for forest valuation in New Zealand. The increase in forest value can be substantial when log prices are low and close to the exercise cost. Gains quickly diminish and become small, both as an absolute difference and as a percentage of forest value, as price increases. However, results are very sensitive to the log price model adopted. Assuming log prices are mean reverting gives higher values than Faustmann for all log prices. Stochastic Dynamic Programming (SDP) and Binomial Option Pricing (BOP) give very similar results. They evaluate the same harvest/defer harvest/never harvest options. A new Abandonment Adjusted Price approach gives results that have a similar pattern but are consistently lower than SDP and BOP. This approach only considers whether to harvest or not in the optimal year and does not allow the option of deferring harvest. At the present time, option valuation approaches have limited relevance for the practice of forest valuation in New Zealand. Practical issues (determination of the log price model, estimation of volatility, allowing for multiple log grades and modelling at the estate-level) need to be addressed before option value approaches can be routinely used for forest valuation.

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    Bibliographic Info

    Article provided by Elsevier in its journal Forest Policy and Economics.

    Volume (Year): 12 (2010)
    Issue (Month): 4 (April)
    Pages: 299-307

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    Handle: RePEc:eee:forpol:v:12:y:2010:i:4:p:299-307

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    Web page: http://www.elsevier.com/locate/forpol

    Related research

    Keywords: Forest valuation Option value Stochastic prices Rotation age;

    References

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    1. Morck, Randall & Schwartz, Eduardo & Stangeland, David, 1989. "The Valuation of Forestry Resources under Stochastic Prices and Inventories," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(04), pages 473-487, December.
    2. repec:ltr:wpaper:1989.01 is not listed on IDEAS
    3. Gong, Peichen & Löfgren, Karl Gustaf, 2007. "Market and welfare implications of the reservation price strategy for forest harvest decisions," Journal of Forest Economics, Elsevier, vol. 13(4), pages 217-243, November.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    5. Gjolberg, Ole & Guttormsen, Atle G., 2002. "Real options in the forest: what if prices are mean-reverting?," Forest Policy and Economics, Elsevier, vol. 4(1), pages 13-20, May.
    6. Insley, Margaret, 2002. "A Real Options Approach to the Valuation of a Forestry Investment," Journal of Environmental Economics and Management, Elsevier, vol. 44(3), pages 471-492, November.
    7. Thomas A. Thomson, 1992. "Optimal Forest Rotation When Stumpage Prices Follow a Diffusion Process," Land Economics, University of Wisconsin Press, vol. 68(3), pages 329-342.
    8. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    9. Harry R Clarke & William J. Reed, 1989. "The Tree-Cutting Problem in a Stochastic Environment: The case of Age Dependent Growth," Working Papers 1989.01, School of Economics, La Trobe University.
    10. Reed, William J., 1993. "The decision to conserve or harvest old-growth forest," Ecological Economics, Elsevier, vol. 8(1), pages 45-69, August.
    11. Bruce McGough & Andrew J. Plantinga & Bill Provencher, 2004. "The Dynamic Behavior of Efficient Timber Prices," Land Economics, University of Wisconsin Press, vol. 80(1), pages 95-108.
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    Cited by:
    1. Manley, Bruce, 2013. "How does real option value compare with Faustmann value in the context of the New Zealand Emissions Trading Scheme?," Forest Policy and Economics, Elsevier, vol. 30(C), pages 14-22.
    2. Tee, James & Scarpa, Riccardo & Marsh, Dan & Guthrie, Graeme, 2010. "A Binomial Tree Approach to Valuing Fixed Rotation Forests and Flexible Rotation Forests Under a Mean Reverting Timber Price Process," 2010 Conference, August 26-27, 2010, Nelson, New Zealand 96836, New Zealand Agricultural and Resource Economics Society.

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