Forest valuation is an important process when it comes to making decisions for forestry investment. Different approaches have been developed to value forests, the Faustmann approach (NPV) being one of the most commonly used. The Option Pricing (OP) approach is an alternative approach that has been proposed but not commonly used in practice. The main aims of this study are to compare these two approaches, analyse their differences and identify their most relevant variables. A Chilean forest estate of 100000 ha was used as a case study.

A key input to both approaches is future log prices. Prices were forecast for this study using a Chilean log prices time series for 1983-2002. In addition, the same time series was used to calculate the historical volatility, another important input of the OP approach.

One of the conditions of the time series in order for it to be statistically reliable is that it has to be stationary. This means that the mean, variance and covariance do not change over time; the condition of stationarity is needed to obtain an accurate forecast. Chilean log prices were first difference stationary. The Box and Jenkins approach was used to determine the model (ARMA models) to forecast log prices. The models chosen for pulplog, sawlog and pruned log prices were ARIMA(0,1,l)(no intercept) obtaining prices of US$17/m3 , US$38/m3 and US$82/m3 • Despite the model predicting constant prices over time, stationarity was achieved.

In the case of the OP approach, prices are supposed to follow a Geometric Brownian motion (GBM). This means that log ratios between prices have to be: normally distributed and independent from past values. Pulplog prices followed a GBM. Sawlog and pruned log prices showed independent from past prices but the normality was not clearly achieved.

The OP approach provided similar values to the NPV approach at a forest estate level. In fact just a difference of 3.7% was found between the Forest Option Value (US$ 643 million, FOV) and the Forest Expectation Value (US$619 million, FEV). For both approaches, in the case study, the discount rate and the harvest cost were the more sensitive variables. The NPV approach was more sensitive than the OP approach when the discount rate and the harvest cost were changed.

The OP approach generally gives higher values than the NPV approach. The main factors that determine the difference between FOV and FEV are the level of historical price volatility, harvest cost and the intensity of silviculture. When volatility was increased to 20% for pulplog and sawlog prices and 10% for pruned log prices, differences in value were over 30% between FOV and FEV. When the harvest cost was increased by 20%, the difference was over 14%. Thus, there was a threshold, above which the OP approach started to provide considerably higher values than the NPV approach.

In the Intensive Management regime the difference between FOV and FEV was low (around 1.5%). When the silvicultural treatment was changed (to Extensive Management), the difference reached approximately 30%. The relatively low volatility of pruned logs, produced under Intensive Management, appears to be the cause of the small difference between FOV and FEV for the Intensive Management regime.

When a stochastic component (prices) is added to forest valuation, values tend to be higher than using deterministic prices. The OP approach incorporates price volatility, therefore forest values are usually higher than for the NPV approach. However, for this case study, similar results were obtained for both the NPV and OP approach, because of the low level of volatility used.

Forest valuation is an important process when it comes to making decisions for forestry investment. Different approaches have been developed to value forests, the Faustmann approach (NPV) being one of the most commonly used. The Option Pricing (OP) approach is an alternative approach that has been proposed but not commonly used in practice. The main aims of this study are to compare these two approaches, analyse their differences and identify their most relevant variables. A Chilean forest estate of 100000 ha was used as a case study.

A key input to both approaches is future log prices. Prices were forecast for this study using a Chilean log prices time series for 1983-2002. In addition, the same time series was used to calculate the historical volatility, another important input of the OP approach.

One of the conditions of the time series in order for it to be statistically reliable is that it has to be stationary. This means that the mean, variance and covariance do not change over time; the condition of stationarity is needed to obtain an accurate forecast. Chilean log prices were first difference stationary. The Box and Jenkins approach was used to determine the model (ARMA models) to forecast log prices. The models chosen for pulplog, sawlog and pruned log prices were ARIMA(0,1,l)(no intercept) obtaining prices of US$17/m3 , US$38/m3 and US$82/m3 • Despite the model predicting constant prices over time, stationarity was achieved.

In the case of the OP approach, prices are supposed to follow a Geometric Brownian motion (GBM). This means that log ratios between prices have to be: normally distributed and independent from past values. Pulplog prices followed a GBM. Sawlog and pruned log prices showed independent from past prices but the normality was not clearly achieved.

The OP approach provided similar values to the NPV approach at a forest estate level. In fact just a difference of 3.7% was found between the Forest Option Value (US$ 643 million, FOV) and the Forest Expectation Value (US$619 million, FEV). For both approaches, in the case study, the discount rate and the harvest cost were the more sensitive variables. The NPV approach was more sensitive than the OP approach when the discount rate and the harvest cost were changed.

The OP approach generally gives higher values than the NPV approach. The main factors that determine the difference between FOV and FEV are the level of historical price volatility, harvest cost and the intensity of silviculture. When volatility was increased to 20% for pulplog and sawlog prices and 10% for pruned log prices, differences in value were over 30% between FOV and FEV. When the harvest cost was increased by 20%, the difference was over 14%. Thus, there was a threshold, above which the OP approach started to provide considerably higher values than the NPV approach.

In the Intensive Management regime the difference between FOV and FEV was low (around 1.5%). When the silvicultural treatment was changed (to Extensive Management), the difference reached approximately 30%. The relatively low volatility of pruned logs, produced under Intensive Management, appears to be the cause of the small difference between FOV and FEV for the Intensive Management regime.

When a stochastic component (prices) is added to forest valuation, values tend to be higher than using deterministic prices. The OP approach incorporates price volatility, therefore forest values are usually higher than for the NPV approach. However, for this case study, similar results were obtained for both the NPV and OP approach, because of the low level of volatility used.

Forest valuation is an important process when it comes to making decisions for forestry investment. Different approaches have been developed to value forests, the Faustmann approach (NPV) being one of the most commonly used. The Option Pricing (OP) approach is an alternative approach that has been proposed but not commonly used in practice. The main aims of this study are to compare these two approaches, analyse their differences and identify their most relevant variables. A Chilean forest estate of 100000 ha was used as a case study.

A key input to both approaches is future log prices. Prices were forecast for this study using a Chilean log prices time series for 1983-2002. In addition, the same time series was used to calculate the historical volatility, another important input of the OP approach.

One of the conditions of the time series in order for it to be statistically reliable is that it has to be stationary. This means that the mean, variance and covariance do not change over time; the condition of stationarity is needed to obtain an accurate forecast. Chilean log prices were first difference stationary. The Box and Jenkins approach was used to determine the model (ARMA models) to forecast log prices. The models chosen for pulplog, sawlog and pruned log prices were ARIMA(0,1,l)(no intercept) obtaining prices of US$17/m3 , US$38/m3 and US$82/m3 • Despite the model predicting constant prices over time, stationarity was achieved.

In the case of the OP approach, prices are supposed to follow a Geometric Brownian motion (GBM). This means that log ratios between prices have to be: normally distributed and independent from past values. Pulplog prices followed a GBM. Sawlog and pruned log prices showed independent from past prices but the normality was not clearly achieved.

The OP approach provided similar values to the NPV approach at a forest estate level. In fact just a difference of 3.7% was found between the Forest Option Value (US$ 643 million, FOV) and the Forest Expectation Value (US$619 million, FEV). For both approaches, in the case study, the discount rate and the harvest cost were the more sensitive variables. The NPV approach was more sensitive than the OP approach when the discount rate and the harvest cost were changed.

The OP approach generally gives higher values than the NPV approach. The main factors that determine the difference between FOV and FEV are the level of historical price volatility, harvest cost and the intensity of silviculture. When volatility was increased to 20% for pulplog and sawlog prices and 10% for pruned log prices, differences in value were over 30% between FOV and FEV. When the harvest cost was increased by 20%, the difference was over 14%. Thus, there was a threshold, above which the OP approach started to provide considerably higher values than the NPV approach.

In the Intensive Management regime the difference between FOV and FEV was low (around 1.5%). When the silvicultural treatment was changed (to Extensive Management), the difference reached approximately 30%. The relatively low volatility of pruned logs, produced under Intensive Management, appears to be the cause of the small difference between FOV and FEV for the Intensive Management regime.

When a stochastic component (prices) is added to forest valuation, values tend to be higher than using deterministic prices. The OP approach incorporates price volatility, therefore forest values are usually higher than for the NPV approach. However, for this case study, similar results were obtained for both the NPV and OP approach, because of the low level of volatility used.