Recently Sony released a list of PSP games that will be compatible with the Vita at launch. Much confusion has been had as pretty much day 1 they said any PSP title you bought through PSN would be able to work on Vita. Guess what, they were partially right. You see if you download the PSP games to your PS3 and sync them up to your Vita that way than all games work. It's only when discussing games that can be downloaded through the Vita store that the list given applies. As much as I dislike IGN they outline it here in a video:

Huh, this got unlocked. Good, 'cause it's pretty useful for those who are disappointed that their downloadable PSP games weren't a part of that linked list.

Well, what this does mean is that this is simply a firmware or store issue and not an actual emulation or backwards compatability issue. So even those without a ps3 should expect most, if not all, of those psp games to become available directly through the vita soon enough.

Good news.
 
Now if only I hadn't created a new account then I could play my digital PSP games without separating them into two piles :(

I'm sure there is some emulation going on to make PSP games work on the Vita. For the most part it should just be a matter of providing the expected OS features, but there may be some need to provide compatibility with various hardware quirks that games may be depending on.  

Given that, I'd be willing to bet that the vast majority, if not every PSP game, will work without issues on the Vita. The limited title selection at the moment is probably the list of titles that have passed quality assurance testing. Hopefully the PS3 loophole doesn't get closed :)

@ChaosDent: I don't think it's a loophole. It's just that some games can't be accessed through the Vita store and will be added in the initial weeks after launch.

Meh wish it could work without the PS3 trick. I mean even a PC/MAC store would be nice.

It's totally understandable why they don't want you to be able to access and buy PSP versions of LBP, Lumines, LBP, and Wipeout through your Vita, but I don't really understand why they wouldn't want you to get to stuff like Ratchet Size Matters or Killzone Liberation.