Skip to content

FRM Part II · FRM Exam Part II · Financial Correlation Modeling - Bottom-Up Approaches

In the Ornstein-Uhlenbeck-type mean-reverting correlation process d(rho) = a*(m - rho)*dt + s*dW, which effect results from increasing the speed parameter a, holding m and s fixed?

Raising a strengthens the pull of correlation toward its long-run mean m, so deviations decay faster and are shorter-lived. It does not change the mean m or the volatility parameter s, and correlation stays random as long as s is positive.

  1. ACorrelation is pulled back toward m faster, so deviations from m are shorter-livedCorrect
  2. BLong-run mean m increases proportionally
  3. CVolatility of correlation increases by a factor of a
  4. DCorrelation becomes constant at its initial value

Explanation

The parameter a controls the speed of reversion. A higher a means a stronger pull toward m, shortening the half-life of deviations. It does not alter m or s directly, and correlation remains random while s is positive.

Did you get it right without looking?

One question tells you little. A timed set on Financial Correlation Modeling - Bottom-Up Approaches shows your real accuracy, how long you take and where you lose marks.

Practise Financial Correlation Modeling - Bottom-Up ApproachesFree diagnostic mock

More Financial Correlation Modeling - Bottom-Up Approaches questions