The Bond OAS computation model used in our bank (The model was created in the 90s and the people who worked on it then are no longer part of the company) uses a fallback interest rate volatility of 27.5%. I am unable to understand the rationale behind this assumption. All I know is the model was created to align with Bloomberg’s OAS model. Why is the fallback volatility of 27.5% used?
Term structure models created in that era frequently used fixed volatility assumptions. These assumptions were usually based on historical realized vols (instead of implied vols from options). A paper published by Salomon Brothers in 1997 reported that the realized volatility for 3-month Treasury rate from 1977 to 1997 to be 27.3%, which might be what the modeler at your bank saw and chose.