Real-Options Aspects of Adjacency Constraints

Nikolaj Malchow-Møller, Niels Strange, Bo Jellesmark Thorsen

Research output: Contribution to journalJournal articlepeer-review

Abstract

An important topic in the forest-management literature is the temporal and spatial arrangement of harvests. The logging of larger tracts of forest land is often found to be detrimental to many environmental as well as social values. For these reasons, constraints are often imposed upon harvesting options on adjacent forest stands. As is often the case with management restrictions, they inflict costs upon the forest owners—in terms of revenues foregone and decreased market values of harvesting. These costs and the associated optimal harvesting plans—subject to the restrictions—have so far only been evaluated using deterministic models. In this paper, we explore the effects of uncertainty on the costs of adjacency restrictions in a rather stylised two-stands real-options model. Furthermore, we examine the optimal harvest rules under adjacency restrictions and uncertainty. Traditional studies addressing real options in a forestry context have applied a single real-option approach. Recent developments by Malchow-Møller and Thorsen (2003) extend the single-dimension case to the handling of two exclusive options. This paper further extends the two-options approach to be able to handle the adjacency problem. We find that costs of adjacency constraints tend to increase with uncertainty and that the optimal harvesting strategies become rather complex in terms of the involved stochastic variables.
Original languageEnglish
JournalForest Policy and Economics
Volume6
Issue number3-4
Pages (from-to)261-270
Number of pages10
ISSN1389-9341
DOIs
Publication statusPublished - Jun 2004
Externally publishedYes

Keywords

  • Real options
  • Geometric Brownian motions
  • Stochastic control
  • Dynamic programming
  • Adjacency constraints
  • Optimal harvesting rules

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