Answer-first summary for fast verification
Answer: Statement 1 is incorrect; Statement 2 is correct.
## Explanation Let's analyze each statement: **Statement 1**: "Both Model 1 (no drift) and the Vasicek model assume parallel shifts from changes in the short-term rate." - **INCORRECT** - Model 1 (no-drift model) does assume parallel shifts, but the Vasicek model does NOT. The Vasicek model incorporates mean reversion, which means that interest rate changes are not parallel - rates tend to revert toward a long-term mean level. **Statement 2**: "The Vasicek model assumes decreasing volatility of future short-term rates." - **CORRECT** - In the Vasicek model, the volatility of future short-term rates decreases over time due to the mean-reverting property. As rates move closer to the long-term mean, their volatility diminishes. Therefore: - Statement 1 is incorrect - Statement 2 is correct The correct answer is **C**.
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Q-80. John Jones, FRM, is discussing the appropriate usage of mean-reverting models relative to no-drift models, models that incorporate drift, and Ho-Lee models. Jones makes the following statements:
A
Both statements are correct.
B
Statement 1 is correct; Statement 2 is incorrect.
C
Statement 1 is incorrect; Statement 2 is correct.
D
Both statements are incorrect.
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