Skip to content

FRM Part II · FRM Exam Part II · The Vasicek and Gauss+ Models

A desk calibrates a Gauss+ style model to the observed term structure. A risk manager notes that the model has several mean-reverting Gaussian factors, and a PCA of historical yield changes shows the first factor explains most variance. Which interpretation of that first factor is most appropriate?

The first principal factor usually acts as a level shift, moving rates of all maturities in the same direction with similar loadings. Slope and curvature are the second and third factors, so describing the first as slope or curvature misidentifies it.

  1. AIt typically behaves like a parallel level shift of the curve, with similar loadings across maturitiesCorrect
  2. BIt represents only the front-end slope with opposite signs on short and long rates
  3. CIt captures curvature with belly rates moving opposite to the wings
  4. DIt is a pure noise term with no economic meaning

Explanation

In PCA of yield changes, the first component usually has loadings of the same sign across maturities, i.e. a level or parallel move. Slope has opposite signs at the ends, and curvature has the belly moving against the wings.

Did you get it right without looking?

One question tells you little. A timed set on The Vasicek and Gauss+ Models shows your real accuracy, how long you take and where you lose marks.

Practise The Vasicek and Gauss+ ModelsFree diagnostic mock

More The Vasicek and Gauss+ Models questions