Market expectations in the UK before and after the ERM crisis

The British pound left the ERM on 16 September 1992 after a period of turbu lence. UK monetary policy soon shifted to lower short interest rates, and a n inflation target was announced. This paper uses daily option prices to es timate how the market's probability distribution of the future mark-pound e xchange rate and UK and German interest rates changed over the summer and a utumn of 1992. The results show, among other things, how various policy dec isions affected the market's assessment of the probabilities of realignment s and lending rate cuts.