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A Binomial Tree Approach to Valuing Fixed Rotation Forests and Flexible Rotation Forests Under a Mean Reverting Timber Price Process

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Author Info

  • Tee, James
  • Scarpa, Riccardo
  • Marsh, Dan
  • Guthrie, Graeme

Abstract

NPV and LEV are established and common approaches to valuing single rotation and infinite rotation forests respectively, when the rotation age is fixed in advanced. More recently, Real Options approaches have been employed to value single and infinite rotation forests with a flexible harvest age. Under a stochastic timber price process, it has been shown that the valuation of a flexible rotation forest is equal or higher than that of a fixed rotation forest, because a flexible harvest regime delays the harvest if the timber price is not favourable, whereas a fixed harvest regime would proceed to harvest regardless of the price. Often, valuation of fixed and flexible rotation ages are compared using 2 different methods – NPV (or LEV) and Real Options. The latter tends to have higher data requirements, employ different assumptions and is much more complex to estimate. Because of these differences, it may be difficult to isolate the cause of the increased valuation. In this work, we apply a relatively simple Binomial Tree method from Guthrie (2009) to value both fixed rotation and flexible rotation forests. This method uses the same data, with the same assumptions for both valuations. By holding everything equal, the difference in valuation is solely attributable to the fixed versus flexible harvesting decisions. Original results for both single and infinite rotations are presented using New Zealand Radiata Pine data. Under a mean reverting timber price process, the Binomial Tree approach offers useful insights on the increased valuation due to flexible harvest decisions.

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Bibliographic Info

Paper provided by New Zealand Agricultural and Resource Economics Society in its series 2010 Conference, August 26-27, 2010, Nelson, New Zealand with number 96836.

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Date of creation: Aug 2010
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Handle: RePEc:ags:nzar10:96836

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Web page: http://www.nzares.org.nz/
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Related research

Keywords: NPV; LEV; Real Options; Optimal Harvest Decision; Agribusiness; Crop Production/Industries; Environmental Economics and Policy; Land Economics/Use;

References

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  1. Reed, William J & Clarke, Harry R, 1990. "Harvest Decisions and Asset Valuation for Biological Resources Exhibiting Size-Dependent Stochastic Growth," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(1), pages 147-69, February.
  2. 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.
  3. Margaret Insley & Kimberly Rollins, 2005. "On Solving the Multirotational Timber Harvesting Problem with Stochastic Prices: A Linear Complementarity Formulation," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 87(3), pages 735-755.
  4. Clarke, Harry R. & Reed, William J., 1989. "The tree-cutting problem in a stochastic environment : The case of age-dependent growth," Journal of Economic Dynamics and Control, Elsevier, vol. 13(4), pages 569-595, October.
  5. Viitala, Esa-Jussi, 2006. "An early contribution of Martin Faustmann to natural resource economics," Journal of Forest Economics, Elsevier, vol. 12(2), pages 131-144, June.
  6. Pindyck, Robert S., 1993. "Investments of uncertain cost," Journal of Financial Economics, Elsevier, vol. 34(1), pages 53-76, August.
  7. Guthrie, Graeme, 2009. "Real Options in Theory and Practice," OUP Catalogue, Oxford University Press, number 9780195380637.
  8. Manley, Bruce & Niquidet, Kurt, 2010. "What is the relevance of option pricing for forest valuation in New Zealand?," Forest Policy and Economics, Elsevier, vol. 12(4), pages 299-307, April.
  9. Eduardo S. Schwartz & Lenos Trigeorgis (ed.), 2004. "Real Options and Investment under Uncertainty: Classical Readings and Recent Contributions," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262693186, December.
  10. 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.
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