FRM Part I · FRM Exam Part I · Modeling Non-Parallel Term Structure Shifts and Hedging
In a principal components analysis (PCA) of changes in the government par or spot yield curve, the first three principal components are most commonly interpreted as which of the following?
The first three principal components of yield curve changes are conventionally interpreted as level, slope, and curvature. The first is roughly a parallel shift, the second a steepening or flattening twist, and the third a butterfly movement, and together they explain most of the curve's variation.
- ALevel, slope (steepness), and curvatureCorrect
- BLevel, volatility, and convexity
- CSlope, credit spread, and liquidity
- DDuration, convexity, and basis
Explanation
Empirical PCA of yield curve changes typically finds that the first three components are level (parallel shift), slope (twist) and curvature (butterfly). Together they usually explain the vast majority of curve variation. The other options mix in concepts that are not PCA factors of the curve.
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