Globalization and integrated financial markets allow companies and investors worldwide to work together more closely—but investors still strongly prefer to buy assets in their own currency or in the US dollar, research suggests. This means US companies that issue bonds only in the dollar are uniquely able to borrow from abroad.
Harvard’s Matteo Maggiori, Chicago Booth’s Brent Neiman, and Columbia’s Jesse Schreger looked at international capital flows from investors’ purchases of corporate securities, using a data set of $27 trillion in investment positions provided to them by Morningstar, an independent investment-research company. They find that investor portfolios are more strongly biased toward their own currencies than standard models, such as the kind used at the Federal Reserve or International Monetary Fund, would imply. If a German company issues securities denominated in Canadian dollars, for example, the buyers of those securities will mainly be Canadian. This bias is so strong “that each country holds the bulk of all securities denominated in their own currency, even those issued by foreign borrowers in developed countries,” the researchers write.
Only large companies have the knowledge and resources to issue securities in a foreign currency—Wal-Mart, for example, issued yen-denominated bonds last year—which means they are essentially the only actors in a given market that can attract overseas investment by issuing securities in prospective investors’ home currency.
One currency, the US dollar, bucks this trend, conferring a benefit on US companies. Because of the dollar’s status internationally, even small US companies “that borrow exclusively in dollars have little difficulty borrowing from abroad,” the researchers write.
“If you pick a small or medium-sized firm that issues in US dollars, and a small or medium-sized Australian firm that issues in Australian dollars, only the former commonly places their securities into international portfolios,” says Neiman.
The research, which included position-level data from mutual funds domiciled in more than 50 countries, also suggests that the US dollar’s dominance has surged in recent decades. The euro also had a strong presence in cross-border holdings of corporate securities, until the 2007–10 global financial crisis, when the researchers document a big shift from the use of the euro to the dollar in denominating international bonds.
“The phenomenon that economists call the ‘exorbitant privilege’ is usually used to represent the idea that the US government can borrow more cheaply because of the dollar’s international prominence,” Neiman says. While it would take more research to quantify any lower cost of borrowing, “our evidence is consistent with the corporate sector also realizing an exorbitant privilege because of the special role of the dollar.”
Matteo Maggiori, Brent Neiman, and Jesse Schreger, “International Currencies and Capital Allocation,” Working paper, February 2018.
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