Answer-first summary for fast verification
Answer: The model coefficient a directly relates to the correlations between the default probability distributions U; of the loans in the portfolio.
D is correct. The correlation between each pair of U distributions is equal to \( a^2 \). A is incorrect because the default probabilities are each mapped to the standard normally distributed variable \( U_i \), however, values in the extreme left tail represent default. Thus, low values of \( F \) or \( Z_i \) correspond with a higher likelihood of default. B is incorrect as high values of \( F \) indicate a strong economy, and low values of \( F \) indicate a weak economy. Consequently, low values of \( F \) correspond with a higher likelihood of default. C is incorrect because \( F \) is a common factor and is equal for all loans in the portfolio.
Author: LeetQuiz Editorial Team
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An intern analyst working for a banking regulatory authority is undergoing an in-house training session focused on understanding the Vasicek model, which is widely used in credit risk management. During the training, the analyst encounters the following equations related to the Vasicek model:
U = αF + √(1- α²)Z
Default rate as a function of F = N^(-1)(PD) − αF / √(1- α²)
What is the accurate statement regarding the Vasicek model?
A
The default probabilities of the individual loans in a portfolio are each mapped to the standard normal distribution Ui, of which values in the extreme right tail represent default.
B
A low value of the factor F indicates that the economy is strong, while a high value of F represents economic weakness.
C
For corporate borrowers, the value of the factor F is higher for loans to companies with more cyclical businesses.
D
The model coefficient a directly relates to the correlations between the default probability distributions U; of the loans in the portfolio.
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