Valuation of real-estate losses via Monte Carlo simulation

Abstract

The valuation of the exposure to real estate market risk has traditionally been difficult due to the lack of appropriate data, returns that do not follow a normal distribution and a lack of adequate methodology. However, regulations such as Basel II, Basel III and Solvency II make it possible to assess real estate market risk using an internal model and through Value at Risk. The study develops a procedure to provide an internal model that values real estate market risk and calculates the capital that guarantees it. Monte Carlo simulations are used to calculate Value at Risk. As result, capital requirements can be established from these results to help with portfolio decision-making of insurance companies that hold real estate. Data used in the study is taken from the General Council of Notaries registered dwellings databases from the Spanish National Statistics Institute covering the time period of 2007–2017. This paper contributes to the literature by proposing a model that incorporates the characteristics of investments, allowing a real and market measure of the risk of loss from real estate.