Pricing Defaulted Italian Mortgages

Abstract

Our paper forecasts the expected recovery rates of defaulted Italian mortgage loans backed by either residential or commercial real estate. We apply an exponential Ornstein-Uhlenbeck process to model the price dynamics at the provincial and regional level, and two haircut models to estimate the liquidation value. Compared to our findings, rating agencies such as Moody's, which use geometric Brownian motion to model the price dynamics, paint a rosier picture with higher recovery rates. As a consequence, non-performing mortgage loans held by Italian banks might be overvalued.

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“…Dhesi et al (2021) also use the IFBM to model and forecast kurtosis in order to obtain more accurate shape of return distributions and measurement of value at risk (VaR). While developing a model to price defaulted Italian mortgages, Pelizza and Schenk‐Hoppé (2020) compare their exponential Ornstein–Uhlenbeck process to a GBM model. Shafii et al (2019) use fuzzy time series and GBM to forecast prices of stocks listed on the Bursa Malaysia stock exchange.…”

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