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Valuation of Timber Harvest Contracts as American Call Options with Modified Least-Squares Monte Carlo Algorithm

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This article presents a Monte Carlo methodology for the valuation of timber harvest contracts in the presence of stochastic timber prices, flexibility in harvest timing, and penalty clauses. Harvest contracts are treated as American call options on the value of timber. The modifications to the least-squares Monte Carlo algorithm necessary to incorporate penalty clauses are presented. The application of the proposed methodology is then demonstrated on a valuation problem characteristic of harvest contracts sold by the Washington Department of Natural Resources.

Keywords: American call option; least squares Monte Carlo; timber harvest contract

Document Type: Research Article

Publication date: October 1, 2010

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