Statement 1 Equilibrium term structure models are factor models that use the observed market prices of a reference set of financial instruments, assumed to be correctly priced, to model the market yield curve.

Statement 2 In contrast, arbitrage- free term structure models seek to describe the dynamics of the term structure by using fundamental economic variables that are assumed to affect interest rates.

Which of the statement(s) regarding equilibrium and arbitrage- free term structure models is incorrect?

a. Statement 2 only

b. Statement 1 only

c. Both Statement 1 and Statement 2