Real options in harvesting decision on publicly owned forest lands

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Real options in harvesting decision on publicly owned forest lands

Author Info

Margaret Insley (Department of Economics, University of Waterloo)
Kimberly Rollins (Department of Resource Economics, University of Nevada)

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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.

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Paper provided by University of Waterloo, Department of Economics in its series Working Papers with number 02009.

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Length: 33
Date of creation: Jan 2002
Date of revision: Jul 2003
Handle: RePEc:wat:wpaper:02009

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Find related papers by 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; Investment Policy

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Arrow, Kenneth J & Fisher, Anthony C, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," The Quarterly Journal of Economics, MIT Press, vol. 88(2), pages 312-19, May. [Downloadable!] (restricted)

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