You may be right about that. I had the PNP switch replaced, a year ago, due to reverse lights not working. This may have taken care of the flashing arrow problem.

Here are few more links and quotes about the flashing arrow.

http://www.matthewsvolvosite.com/
"...... The PNP switch failure is when you see the dreaded Flashing Arrow. The car stays at 3rd gear and drives REALLY slow. Shifting it back and forth cleans the contacts but I think it'll eventually fail. Apparently this problem shows up in cold weather....."

http://www.brickboard.com/ARCHIVES/1999OCT/10018372.shtml
"..... When the dreaded flashing arrow light comes on means the on board computer sensed the input and output shaft speeds were not as expected. I took the vehicle to the dealer and they confirmed the slipping and burnt oil. They told me they may not be able to get a new transmission since the replacement parts had a "warrantee hold" - whatever that means......"

http://cartalk.cars.com/Survey/Results/Demographics/Comments/Volvo/960-1992.html
"....... Overall, I am very pleased with the car. It is expensive to maintain and has a few quirks, however it has been reliable, ................. During the winter the transmission occasionally kicks into the default winter mode(stuck in third gear with a bright flashing arrow on the dashboard) on its own. I found out that by shutting off the car and jiggling two of the fuses, the transmission works normally again even though the arrow flashes for the next several days......."