Real options in harvesting decisions on publicly owned forest lands (Revised)

This paper develops a two factor real options model of the harvesting decision over infinite rotations with mean reverting stochastic prices using a rigorous HamiltonJacobi-Bellman methodology. The harvesting problem is formulated as a Linear Complementarity Problem which is solved numerically using a fully implicit finite difference method. This approach is contrasted with Markov Decision Process models commonly used in the literature. 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 is contrasted with the value of the stand when regulations dictate a window of time during which harvesting must occur.