In Discussion paper No 1307 Zsolt Darvas examines the domestic money market and foreign exchange market developments in Hungary after the announcement of the new monetary and fiscal policy in March 1995. While the spot market exchange rates stayed fairly close to the lower (strong) edge of the target zone of the National Bank of Hungary (NBH) for nearly the whole period under examination (March to August), interest rates and forward and futures exchange rates continued to move upwards for some time, despite the general expectation of (slow) downward movement. Forward rates for more than six months to maturity exceeded the projected target zone of the NBH, which might have signified lack of credibility in exchange rate policy according to Svensson's simplest test. Ex-post premia on Forint assets were also moving upwards and reached 12% (sixteen percentage points) at annual base.

The author examines whether this fact reflects an additional devaluation expectation or whether it might be attributed to other factors, e.g. risk aversion or market inefficiency. Though in recent years the average premium on Forint assets was close to zero, past performance of the interest rate differential, as an indication of exchange rate movements, was poor; there is no real cointegrating relationship to be found. By calculating implicit probabilities of additional devaluations for the present situation, the conditions of risk neutrality and rational expectations can be rejected because the implied probabilities seem to be `too large'. The main conclusion of the paper is that uncovered interest parity does not hold for the present Hungarian foreign exchange market; forward rates falling outside the projected band do not necessarily reflect lack of credibility in exchange rate policy.