The findings of previous researchers indicated that Treasury securities, especially one-month maturities, have a default premium embedded in their yields during debt-related crises. There is also real-world evidence of the existence of such a default premium, as reported by the business press during the 2013 US government shutdown. This evidence includes credit rating downgrades and watches as well as China’s expressions of concern accompanied by its call for a new international reserve currency. In this study, the authors extend previous empirical research and supplement real-world observations by examining the behavior of short-term Treasury yields during the shutdown.

The authors find that, overall, the rate on four-week Treasury bills significantly increased during the government shutdown. They also find that the spread of one-month AA rated commercial paper over four-week Treasury bills was negative during most of the period.

The authors’ findings suggest that the increase in the one-month Treasury yields occurred without a corresponding increase in AA rated nonfinancial commercial paper. This finding, in turn, implies that the shutdown increased the default risk of those Treasuries by increasing the probability that the federal government would not raise its debt ceiling. The increase in default risk resulted in the one-month Treasury yield being 21 bps higher than the comparable commercial paper yield. Should this scenario repeat, the authors estimate that based on projected US Treasury debt levels, it could potentially cost US taxpayers an extra $35.7 billion in interest costs.

They do not find a similar increase in the yields of the three-month Treasury securities—the next level of maturity—which indicates that the market expected the situation to be resolved quickly.

Despite the apparent short-term impact of government debt ceiling crises on US Treasury default risk, the authors believe that their findings have other lasting implications. According to them, sufficient evidence now exists to challenge academics’ long-held belief that Treasuries are default-risk free. The authors also caution lawmakers about the perils of even short-term disagreements about the debt limit and government spending. Such disagreements can only increase Treasury yields and the interest cost of Treasury debt. They can also lead to a loss of confidence by investors and credit rating agencies.

Finally, the authors warn market participants about the potential impact that periodic increases in default risk can have on the presumed high liquidity of Treasury bills—while also noting that their findings can be used to create arbitrage opportunities.

The authors use an event study approach focusing on two different spreads—the one-month rate on AA rated nonfinancial commercial paper minus the rate on four-week Treasury bills and the three-month rate on AA rated nonfinancial commercial paper minus the rate on three-month Treasury bills. They obtain the business daily rate data from the Federal Reserve Board’s Statistical Release H.15.

The authors estimate the distribution of each spread using available business daily rates for 1 October 2012 to 30 September 2013. They then use a t-statistic to compare the daily value of each spread during the October 2013 shutdown period with its mean value during the year prior to the shutdown. Using a nonparametric Mann–Whitney test, they compare the median value of each spread during the shutdown period with its median value during the year prior to the shutdown.

Finally, the authors run regression analyses for 1 October 2012 to 31 October 2013 to examine the relationship between the government shutdown period (coded as a dummy independent variable) and each spread (the dependent variable). They use the Consumer Price Index urban area and Eurodollar yield variables to control for inflation and interest rate movements, respectively. Coefficient values are tested for significance by using Newey–West-adjusted t-statistics.

For the purposes of this study, the authors define default as being late on any payment associated with a security, even if it is for a short period of time.

The authors incrementally expand the existing body of research by applying their event study approach to the examination of short-term Treasury yields during the government debt ceiling crisis and government shutdown in 2013. The authors’ interweaving of their account of the empirical study with excerpts from articles that appeared in the business press during the height of the crisis helps to enhance the relevance of their research for investment professionals.