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

A risk analyst describes the Gauss+ model used by Tuckman and Serrat for fixed income risk. Which statement best describes its structure?

Gauss+ is a multi-factor Gaussian term structure model. Rate changes are normally distributed and driven by a small number of factors, giving tractability and a realistic spread of volatility across maturities. It is not a single-factor lognormal model and does not rely on jumps.

  1. AA multi-factor Gaussian model with a few factors in which rate changes are normally distributed and volatilities depend on factor loadings across maturitiesCorrect
  2. BA single-factor lognormal model in which the short rate cannot fall below zero
  3. CA model whose factors are driven by jump processes with fat-tailed distributions
  4. DA model in which the term structure is fixed and only the credit spread is random

Explanation

Gauss+ is a multi-factor Gaussian (normal) rate model, with factors capturing level, slope and curvature type movements, and a Gaussian structure that keeps the model tractable. The lognormal single-factor option describes a different model, such as Black-Karasinski, and the jump option does not describe Gauss+.

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