Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 210: Market Expectations in the UK Before and After the ERM Crisis

Paul Söderlind ()
Additional contact information
Paul Söderlind: Dept. of Economics, Stockholm School of Economics, Postal: P.O. Box 6501, SE-113 83 Stockholm, Sweden

Abstract: The British pound left the ERM on 16 September 1992 after a period of turbulence. UK monetary policy soon shifted to lower short interest rates and an inflation target was announced. This paper uses daily option prices to estimate how the market's probability distribution of the future marks/pound exchange rate and UK and German interest rates changed over the summer and autumn of 1992. The results show, among other things, how various policy decisions affected the market's assessment of the probabilities of realignments and lending rate cuts.

Keywords: Interest rates; exchange rates; futures; options; risk neutral distribution

JEL-codes: E43; E52; G13

25 pages, First version: December 8, 1997. Revised: March 19, 1999. Earlier revisions: September 1, 1998, August 28, 1998, March 19, 1999.

Note: Old title: Extracting Expectations about UK Monetary Policy 1992 from Option Prices

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