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: September 2020
Keyword(s): Endogenous entry, Geography of flows, Profit shifting, risk, safe assets, Tax avoidance, tax havens
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

Using a unique confidential data set with industry disaggregation of official U.S. claims and liabilities, we find that the growing dollar-denominated securities are also increasingly intermediated by tax havens financial centers (THFC) and by less reg- ulated 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 official 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 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.