Searching for yield abroad: risk-taking through foreign investment in U.S. bonds
BIS Working Papers No 687
This paper measures the importance of risk-taking in foreign investment in U.S. corporate bonds. Low interest rates have been argued to spur the search for yield. This can affect domestic investments, but also capital flows across countries, including into key advanced economies such as the United States.
This paper tests for search for yield by examining whether changes in interest rates in 36 countries drove domestic investors to shift into riskier assets in the United States. The analysis uses unique, security-level data on foreign holdings in close to 15,000 U.S. corporate bonds between 2003 and 2016.
We overcome challenges faced by other studies by focusing on interest rates in the investor country and not the destination country, and using data on foreign investments. Rates in the destination country depend on economic conditions, which have an impact on borrowers' riskiness and their demand for external financing. This makes it hard to separate out the impact of rates on risk-taking in the same economy. And when investments affect spreads for individual borrowers, spreads cannot be used are measures of borrowers' risks. Foreign holdings, which are typically small, do not raise this problem.
We find clear evidence that the more interest rates at home decline, the more investors shift their international bond portfolios toward riskier U.S. corporate bonds. Effects are even stronger when home interest rates reach a low level, suggesting that risk-taking accelerates as rates decline. These effects hold regardless of secondary market liquidity and other factors.
We cannot tell whether this behaviour also applies to other investment patterns, since we not have those data. But if it does, this could bring financial stability risks, particularly if the low-rate environment persists.
The risk-taking effects of low interest rates, now prevailing in many advanced countries, ("search-for-yield") are hard to analyze due to both a paucity of data and challenges in identification. Unique, security-level data on portfolio investment into the United States allow us to overcome both problems. Analyzing holdings of investors from 36 countries in close to 15,000 unique U.S. corporate bonds between 2003 and 2016, we show that declining home-country interest rates lead investors to shift their international bond portfolios toward riskier U.S. corporate bonds, consistent with "search-for-yield". We estimate even stronger effects when home interest rates reach a low level, suggesting that risk-taking in securities accelerates as rates decline.
JEL classification: F21, F34, G11, G20
Keywords: low interest rates, search for yield, portfolio choice, corporate debt