Layman’s abstract for Applied Stochastic Models in Business and Industry on Real option valuation of timber harvesting contracts

Each week, we publish layman’s abstracts of new articles from our prestigious portfolio of journals in statistics. The aim is to highlight the latest research to a broader audience in an accessible format.
The article featured today is from Applied Stochastic Models in Business and Industry with the full article now available to read here.
Herath, HSBJahera, JSReal option valuation of timber harvesting contractsAppl Stochastic Models Bus Ind20211– 23
Timber harvesting contracts have become increasingly important to the forest industry and consequently the valuation of timber harvesting rights is a common topic in both business and forest economics. Uncertainty in lumber prices can add considerable risk, and real option theory provides an elegant approach to the treatment of uncertainty in forest resource decisions. A primary challenge for forestry businesses is valuing timber harvesting contracts and managing business risk. The optimal tree harvesting problem under stochastic prices is investigated using real option theory.  An explicit binomial lattice approach with stochastic dynamic programming that is reducible to a simpler deterministic dynamic program for determining the optimal harvest is demonstrated. This approach is much easier to implement.  Why forestry businesses should consider the choice between a single long-term and two short-term timber harvesting contracts from a risk management perspective is highlightedAn illustrative example using public tender information from the British Columbia Gazette provided through the Small Business Forest Enterprise Program (SBFEP) and the Ministry of Forests demonstrate that forestry businesses can benefit by timing their harvest to non-equal quantities in later years of a timber harvesting contract.  
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