Elusive Safety: The New Geography of Capital Flows and Risk

Laura Alfaro, Ester Faia, Ruth A. Judson, Tim Schmidt-Eisenlohr

NBER Working Paper No. 27048
Issued in April 2020, Revised in May 2020
NBER Program(s):Corporate Finance, International Finance and Macroeconomics, International Trade and Investment

Using a unique confidential data set with industry disaggregation of official U.S. claims and liabilities, we find that dollar-denominated securities are increasingly intermediated by tax havens financial centers (THFC) and by less regulated funds. These securities are risky and respond to tax rates and prudential regulations, suggesting tax avoidance and regulatory arbitrage. Issuers are mostly intangible-intensive multinationals, investors require a high Sharpe ratio, suggesting search for yield. In contrast, safe treasuries are mainly held by the foreign offcial sector and increased with quantitative easing policies. Facts on privately held securities are rationalized through a model where multinationals with heterogeneous default probabilities endogenously choose to shift profits and are funded by global intermediaries with endogenous monitoring intensity. A fall in corporate taxes raises the fraction of entrants and shifts the distribution toward riskier ones. A fall in the costs of global funds or in THFC regulation costs additionally reduces the monitoring intensity at the extensive (fraction of monitored firms) and intensive margin, hence raising ex post risk. Firms appear elusively safe.

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Acknowledgments

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Document Object Identifier (DOI): 10.3386/w27048