DP14636 Elusive Safety: The New Geography of Capital Flows and Risk

Author(s): Laura Alfaro, Ester Faia, Ruth Judson, Tim Schmidt-Eisenlohr
Publication Date: April 2020
Date Revised: February 2021
Keyword(s): Endogenous entry, endogenous monitoring, Heterogeneous Firms, regulatory arbitrage, risk, Tax avoidance, Tax havens/Financial Centers, uncertainty
JEL(s): F2, F4, G15
Programme Areas: International Macroeconomics and Finance, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14636

A confidential dataset with industry-level disaggregation of U.S. cross-border claims and liabilities, shows U.S. securities to be increasingly intermediated by tax-haven- financial-centers (THFC) and less regulated funds. These securities are risky, in intangible-intensive sectors, requiring higher Sharpe ratios; while the foreign-official sector mainly holds Treasuries. Facts on private securities are rationalized through a model where firms with heterogeneous default probabilities, and funded by global intermediaries, endogenously locate affiliates in THFCs. A decline in the cost of funds or in THFC's taxes/regulation, raises profits and firms' incentives to enter THFCs. Firms appear elusively safe, intermediaries reduce monitoring incentives and debt risk increases.