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#1

Hi,

The Vasicek model assumes that the asset value of a given obligor is given by the combined effect of a systematic and an idiosyncratic factor and that each obligor

X

and S and Z are respectively the systematic and the idiosyncratic component and rho is the asset correlation between two different obligors.

My question is why is the "sqrt" required in this formulation rather than simply:

X

The Vasicek model assumes that the asset value of a given obligor is given by the combined effect of a systematic and an idiosyncratic factor and that each obligor

*i*defaults if a certain random variable X*i*falls below a threshold whereX

*i*= S * sqrt(rho) + Z * sqrt(1-rho)and S and Z are respectively the systematic and the idiosyncratic component and rho is the asset correlation between two different obligors.

My question is why is the "sqrt" required in this formulation rather than simply:

X

*i*= S * rho + Z * (1-rho)
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