John Jones, FRM, is discussing the appropriate usage of mean-reverting models relative tono-drift models, models that incorporate drift, and Ho-Lee models. Jones makes the following statements:
Statement 1: Both Model 1 (no drift) and the Vasicek model assume parallel shifts from changes in the short-term rate.
Statement 2: The Vasicek model assumes decreasing volatility of future short-term rates while Model 1 assumes constant volatility of future short-term rates.
Statement 3: The constant drift model (Model 2) is a more flexible model than the Ho-Lee model.
How many of his statements are correct?
A. 0
B. 1
C. 2
D. 3
Answer:B
Only statement 2 is correct. The Vasicek model implies decreasing volatility and non-parallel shifts from changes in short-term rates. The Ho-Lee model is actually more general than Model 2(the no drift and constant drift models are special cases of the Ho-Lee model).