Developments in finance have prompted the formation of a Network on Financial Markets to encourage interaction among European researchers in the area. The network, established under the auspices of the European Science Foundation, is administered by the Centre for Economic Policy Research and chaired by Colin Mayer, Co-Director of CEPR's Applied Microeconomics programme. The first meeting of the Network, held in April 1989, was devoted to `Corporate Finance' see the report in Bulletin No. 32. For the second meeting, held at the Institut Européen d'Administration des Affaires (INSEAD) in Fontainebleau on 4/6 October and organized by Jean Dermine (INSEAD), the theme was `The Regulation of Banking and Financial Markets'.
Colin Mayer (City University Business School and CEPR) discussed `Regulation of Financial Services: Lessons from the UK for 1992'. Mayer argued that the sources of market failure in the operations of brokers and dealers were different from those in the operations of investment managers, so that different approaches should be taken to the construction of regulations for each. The importance of brokers in the provision of liquidity in capital markets suggested an emphasis on equity regulations. For investment managers dealing with private clients the most relevant sources of market failure were adverse selection and moral hazard, so regulation should aim to establish whether agents are `fit and proper' and draw up codes of conduct.
The behaviour of individual agents in markets was also the focus of the paper by Paul Seabright (Churchill College, Cambridge, and CEPR) on `Short-Termism in Financial Markets: A Principal-Agent Model with Externalities'. Seabright developed a model of trading and promotion decisions within a financial institution which operated in both securities markets and commercial banking. The length of employment of agents in securities markets was determined in the model, and information about their performance was used to screen agents for promotion in other markets, where their performance could not be monitored ex post. Kim Staking (University of Pennsylvania) and Tom Aiuppa (University of Wisconsin) examined `Insurance Regulation and the Control of Agency Conflict' in the US property insurance market, in which several forms of organization compete. Staking and Aiuppa examined how firms chose to operate in different markets and suggested that different organizational forms, such as stock insurance and mutual insurance, created different degrees of agency conflicts, requiring different methods of control.
Lars Nielsen (INSEAD) analysed expectations formation in the presence of `Common Knowledge of a Multivariate Aggregate Statistic'. He used a capital asset pricing model in which asset prices took the form of a stochastic, monotone aggregate of expectations of returns on the asset formed by asymmetrically informed investors. The model suggested that, in any equilibrium where prices are common knowledge and expectations are formed rationally, investors must agree on their expectations despite the presence of asymmetric information.
Eric Briys (Centre HEC-ISA, Jouy-en-Josis), Michel Crouhy (Centre HEC-ISA, Jouy-en-Josis) and Rainer Schobel (Universität Lüneburg) evaluated `The Pricing of Interest Rate Cap, Floor and Collar Agreements' in a contingent-claim, continuous-time framework. Their model treated these instruments as options on traded, zero-coupon bonds and in which the stochastic variables were the bond prices themselves, the authors derived preference-free, closed-form solutions for the pricing of these instruments.
Although there is a widespread view among market practitioners that futures markets can have destabilizing effects on spot markets, theorists have not been able to design models which exhibit destabilizing properties. Roger Guesnerie (DELTA, ENS/EHESS, Paris) and Charles Rochet (Université de Toulouse I) presented their paper on the `Destabilizing Properties of Futures Markets: A New Approach'. While previous analyses had focused on the variance of the spot price, Guesnerie and Rochet examined instead the coordination of agents and in particular the process through which agents are persuaded to adopt their equilibrium strategies under rational expectations. The establish ment of futures markets could prevent the convergence on equilibrium.
In their paper, Philippe Aghion (DELTA), Patrick Bolton (Ecole Polytechnique) and Mathias Dewatripont (Université Libre de Bruxelles) examined `Interbank Lending and Contagious Bank Runs' caused by shocks to banks' liquidity. The probability that an individual bank will fail as the result of a liquidity shock can be reduced by the facility of interbank lending, so long as the shock is not perfectly correlated across banks. In the authors' model, however, if an individual bank is allowed to fail despite the possibility of interbank lending, this provides a signal concerning the inability or unwillingness of other banks to lend and so may propagate further failures through a bank run.
In `Deposit Rate Ceilings and the Market Value of Banks: The Case of France', Jean Dermine and Pierre Hillion (INSEAD) assessed the relationship between the market value and the asset liability structure of French banks. Having developed and tested a simple model of bank valuation, Dermine and Hillion analysed the determinants of the 1974 drop in banks' market values, a large part of which could be attributed to the inflation tax.

A full report of this meeting will be available in the March 1990 Newsletter of the European Science Foundation Network in Financial Markets. The Newsletter is sent automatically to members of the Network, which is open to all researchers working in Europe in any area of the economics of financial markets. Further information and copies of the Newsletter can be obtained from Wendy Thompson at CEPR.