For instance, large fluctuations in asset prices may modify the behaviour of agents by decreasing the level of confidence. Such fluctuations can also expose bank portfolios to a higher risk of losses, inducing banks to compensate for these risks by restricting credit. Let me stress that, although a price stability oriented monetary policy is conducive to financial stability over the long term, episodes of financial instability have been known to take place during periods of low inflation. Price stability must be therefore regarded as a necessary but not sufficient condition. Other parameters influence financial stability, among which financial integration is of particular interest from the point of view of a central bank in the Euro area. 2.2  The relationship between financial integration and financial stability is twofold:  –  First, the liquidity redistribution function has taken on a new dimension as participants in the market are dealing with a wider range of counterparties, and actually trade larger unit amounts. Some bank treasurers in Paris mention that the average face value in euro of single transaction today is equivalent to the face value of a transaction in French franc in 1998, that is, more than six times higher. –  Second, financial market integration is related to the trend towards the greater share of markets in the allocation of assets. At the end of 2000 financial assets in the euro area were 10 split almost equally between intermediated and non-intermediated assets.
From a general point of view, volatility is a kind of genetic signature of the price setting mechanism in a competitive market. Prices hover around the equilibrium through successive adjustments. When market participants express widely different views on this equilibrium price, or when the volume of transaction shrinks, volatility usually increases. In this respect, there is a close correlation between the occurrence of crises - such as the revealed insolvency of an emerging country, supply shocks on commodity prices, bursting of equity bubbles - and excessive volatility. Volatility is not an indicator of market inefficiency. However, excessively high volatility has adverse effects on the behaviour of market participants and the real economy. From a corporate management point of view, volatility on capital markets lowers the predictability of the cost of capital. When reviewing investment opportunities, managers may want to avoid relying too heavily on external finance because of the uncertainties surrounding the cost, or even the sheer availability, of financing. This may lead companies to postpone or downsize investment projects. From a financial management point of view,  11  Estimation in “Central banks and financial stability - exploring an intermediate land” - Second ECB central banking conference - 2002. 12  BRI - Economic aspects of regional currency areas and the use of foreign currencies - 2002 - document non publié. BIS Review 2/2003  5  large investors may give priority to companies with a low risk profile, in order to bring back their own asset portfolios to levels of volatility matching their requirements.