International Currencies and Capital Allocation

Using a new security-level dataset covering $32 trillion in global investment positions, this paper establishes that the currency a bond is denominated in – not the nationality of its issuer – is the dominant predictor of who holds it, and that this home-currency bias leaves most firms borrowing only at home while a small number of large foreign-currency issuers capture nearly all foreign bond capital. The data are Morningstar’s complete position-level holdings of open-end mutual funds and exchange-traded funds domiciled in over 50 countries, filtered to the 23 countries (14 of them inside the euro area, leaving 10 effective country units) where Morningstar’s coverage of fixed-income assets under management is at least a quarter of what the Investment Company Institute reports. Four facts follow. First, home-currency bias is strong and is identified within firm: comparing an investor country’s share of two bonds issued by the same parent but denominated differently, and controlling for maturity and coupon, Canadian funds hold a share of a Canadian-dollar bond about 90 percentage points larger than of a non-Canadian-dollar bond from the same issuer, with similarly large and precisely estimated coefficients for every other country (Table 2, p. 12). Running home-country and home-currency indicators side by side, the currency coefficient and R-squared are roughly twice those on country alone, and adding currency collapses the country coefficient while barely moving the currency one – so, at least for corporate bonds, the classic home-country bias documented since French and Poterba (1991) is largely confounded by home-currency bias (Table 4, pp. 14-15). Second, home-currency bias travels with a stark allocation of capital across firms: in each country a small number of large firms issue in foreign currency and borrow from foreigners, while most firms issue only in local currency and are held almost entirely by domestic investors. Probit estimates using Compustat, Worldscope and SDC data show that bigger firms are significantly more likely to issue in foreign currency on all four size proxies used (Table 5, p. 17). That this is not simply about which firms foreigners find unappealing is shown by the fact that the same local-currency-only firms do receive foreign equity investment (Figure 9b, p. 20). Third, the United States is the exception: a significant mass of medium-sized US firms issues only in dollars yet receives substantial foreign financing, which the authors read as the global taste for dollar debt effectively opening the capital account for local-currency US borrowers – a pattern found for no other country in the data (Section 4, pp. 16, 19-20). Fourth, in the time series the dollar’s role is recent rather than permanent: the dollar denominated 41 percent of global cross-border corporate debt holdings in the data in 2005 and the euro 38 percent, shares that were largely stable until 2008, after which the euro’s fell to 22 percent and the dollar’s rose to 63 percent (Introduction, p. 2; Section 5, pp. 21-22). The paper is explicit about its scope: the dataset contains quantities but not prices, so it cannot assess borrowing costs or quantify the value of the dollar’s privilege; it covers bond finance only and excludes bank lending; the analysis is of corporate rather than sovereign bonds; and the authors deliberately establish the four facts without identifying the mechanisms behind them, offering hedging costs, market segmentation by currency and fixed issuance costs as candidate explanations for future work to formalize.

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International Currencies and Capital Allocation