In the Vasicek Model, what does 'theta' represent?

In the Vasicek model, 'theta' represents the long-run mean-reverting level of interest rates. The model is designed to simulate the evolution of interest rates over time, reflecting the tendency of interest rates to revert to a long-term average. This mean-reverting characteristic is a key feature of the Vasicek framework, which suggests that fluctuations in interest rates will gradually return to this 'theta' level, thereby embodying the concept of mean reversion.

Understanding 'theta' in this context is crucial because it helps in quantifying how interest rates are expected to adjust over time in reaction to shocks or changes in economic conditions. The other factors in the model, such as the drift of short-term rates or the volatility factor, play significant roles but are distinctly separate from 'theta', emphasizing its specific purpose within the mean-reverting behavior of rates. This separates 'theta' as crucial in context of the long-run equilibrium around which rates fluctuate.