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Answer: Once estimated, the short-term rate, medium-term factor and long-term factor are set equal to the fed funds target rate, the one-year rate that is two-year forward and the one-year rate that is ten-year forward, respectively.
## Explanation Option C is correct because in the Gauss+ model estimation methodology: - The **short-term rate** is typically set equal to the **fed funds target rate** (or a similar short-term policy rate) - The **medium-term factor** is set equal to the **one-year rate that is two-year forward** - The **long-term factor** is set equal to the **one-year rate that is ten-year forward** This approach provides a practical way to initialize the state variables in the Gauss+ model using observable market rates. ### Analysis of Other Options: **Option A**: Incorrect - To estimate mean reversion parameters, one typically regresses changes in long-term yields on changes in short-term yields, not the other way around. **Option B**: Incorrect - Matching the term structure of volatilities is used to estimate volatility parameters, not the long-term mean reversion level (μ). **Option D**: Incorrect - While this practical method is more intuitive, maximum likelihood methods are generally considered more statistically rigorous and are standard in academic literature, though they can be more complex to implement.
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The practical estimation method for Gauss+ model's parameters proceeds in stages, with each stage estimating a subset of the model's parameters. Which of the following statements is correct regarding the estimation method?
A
In order to estimate the mean reversion parameters, one should first regress the changes in the zero yields of medium-long-term bonds on the changes in the zero yields of various terms.
B
In order to estimate the value to which the short-term rate reverts over the very long-term (i.e., the constant ), we should ensure that the term structure of volatilities in the model matches the term structure of volatilities in the data as closely as possible.
C
Once estimated, the short-term rate, medium-term factor and long-term factor are set equal to the fed funds target rate, the one-year rate that is two-year forward and the one-year rate that is ten-year forward, respectively.
D
This practical estimation method is significantly easier to implement than the maximum likelihood methods that are standard in the term structure literature.