Sell or Hold? On the Value of Non Performing Loans and Mandatory Write-Off Rules

40 Pages Posted: 23 Nov 2020 Last revised: 26 May 2021

See all articles by Florian Pauer

Florian Pauer

Vienna University of Economics and Business - Department of Finance, Accounting & Statistics

Stefan Pichler

WU - Vienna University of Economics and Business - Department of Finance, Accounting and Statistics; VGSF (Vienna Graduate School of Finance)

Date Written: May 17, 2021

Abstract

In this paper, we study the impact of mandatory write-off rules on a bank's reservation price
of a non-performing loan (NPL). We develop a model of information asymmetry in NPL markets
where agents are using risk neutral pricing. In contrast to existing literature, we assume
that agents agree on the expected recovery rate of an NPL. We show that differences in the
estimation accuracy of the drift of the underlying recovery rate process lead to valuation
differences. In the model, the differences in the precision when estimating the drift of the
underlying lead to differences in the aggregated variance of the payoff distribution. Since an
NPL's payoff function is nonlinear this results in different NPL valuations depending on this
precision parameter. This, in combination with capital adequacy requirements banks need
to maintain and funding costs they face leads to the result that a bank's reservation price of
an NPL might be below its own valuation.

Keywords: non performing loan, mandatory write-off rules

JEL Classification: G13, G21, G28, D82

Suggested Citation

Pauer, Florian and Pichler, Stefan, Sell or Hold? On the Value of Non Performing Loans and Mandatory Write-Off Rules (May 17, 2021). Available at SSRN: https://ssrn.com/abstract=3705251 or http://dx.doi.org/10.2139/ssrn.3705251

Florian Pauer (Contact Author)

Vienna University of Economics and Business - Department of Finance, Accounting & Statistics ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

Stefan Pichler

WU - Vienna University of Economics and Business - Department of Finance, Accounting and Statistics ( email )

Heiligenstaedter Strasse 46-48
Wien 1190
Austria

VGSF (Vienna Graduate School of Finance) ( email )

Heiligenstaedter Strasse 46-48
Vienna, 1190
Austria

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