Elusive Safety: The New Geography of Capital Flows and Risk

Using a unique confidential data set with industry-level disaggregation of U.S. cross-border securities claims and liabilities, we find that the growing U.S. securities are also increasingly intermediated by tax haven financial centers (THFC) and by less regulated funds. These securities are risky and respond to tax rates and regulation, suggesting tax avoidance and regulatory arbitrage. Issuers are mostly intangible-intensive multinationals, and investors require a high Sharpe ratio, suggesting search for yield. In contrast, safe Treasuries are mainly held by the foreign official sector and increased with quantitative easing policies. Facts on private 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 the costs of global funds, by increasing firms’ profits, shifts the distribution of entrants toward riskier ones and also reduces intermediaries’ incentives to monitor both the extensive (fraction of monitored firms) and intensive margin, hence raising ex post risk. Firms appear elusively safe.