Suppose that a=0.1, b=0.08, and σ=0.015 in Vasicek's model, with the initial value of the short

Question

Accepted Answer

Step 1: Calculate the mean reversion level.
The mean reversion level, $mu$, is given by the form

Suppose that $a=0.1, b=0.08$, and $\sigma=0.015$ in Vasicek's model, with the initial value of the short rate being $5 \%$. Calculate the price of a 1 -year European call option on a zerocoupon bond with a principal of $$\$ 100$$ that matures in 3 years when the strike price is $$\$ 87$$.