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

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