A junior analyst at a banking supervisory agency is taking an internal training class on the Vasicek model. The analyst reviews the following equations related to the model:

$U_i = a_i F + \sqrt{1 - a_i^2} Z_i$

Default Rate as a function of $F = N\left(\frac{N^{-1}(PD) - aF}{\sqrt{1 - a^2}}\right)$

Which of the following statements regarding the Vasicek model is correct?

Exam-Like

A

The default probabilities of the individual loans in a portfolio are each mapped to the standard normal distribution $U_i$ , 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 $U_i$ of the loans in the portfolio.

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Financial Risk Manager Part 1

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