Skip to content

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

In the Vasicek model, the short rate follows dr = k(θ − r)dt + σ dw. A risk analyst explains the role of the parameter k to a new colleague. Which statement is correct?

The parameter k is the speed of mean reversion. It determines how strongly the drift pulls the short rate back toward the long-run level θ, while σ is the volatility and θ is the long-run mean rate.

  1. Ak is the speed at which the short rate is pulled toward its long-run level θCorrect
  2. Bk is the instantaneous volatility of the short rate
  3. Ck is the long-run mean level of the short rate
  4. Dk is the market price of interest-rate risk

Explanation

In dr = k(θ − r)dt + σ dw, the drift is positive when r is below θ and negative when r is above it, and k scales the strength of that pull. Volatility is σ and the long-run level is θ, so those options mislabel the parameters.

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