The launch of HUFONIA and the related international experience of overnight indexed swap (OIS) markets

In relation to the October 2010 launch of the HUFONIA Swap Index, we discuss the most important characteristics of the overnight indexed swap (OIS) market, one of the fastest-growing segments of advanced money markets. OIS contracts allow for the cost-effective management of short-term interest rate risks while also facilitating profitable investment strategies to foresee the central bank's interest rate decisions, which, according to international experience, have greatly contributed to their popularity. A further benefit of OIS contracts is that partners’ credit risk and counterparty limits only play a minor role in their pricing. Looking at the underlying motives of central banks in market development, empirical analyses show that OIS markets can provide one of the most accurate indicators of short-term interest rate expectations, and could furnish additional information in the preparation and evaluation of monetary policy decisions. In conjunction, the financial crisis brought attention to the significance of the so-called LIBOR-OIS spread, an indicator also suitable for assessing the solvency of the banking system. The essential conditions of market development, such as the availability of a reliable reference rate and the presence of foreign market makers, are ensured in Hungary. However, due to the limited market size the fixed costs of market development are somewhat higher than in major currency areas. Nearly half of market makers have prepared their trading and accounting systems for transactions until 2011 Q2. Market activity could be driven by strategies aimed at mitigating or converting banks’ exposure to interest rate risks in the future.