Failed Delivery and Daily Treasury Bill Returns

Abstract:     
If the seller of a Treasury bill does not provide timely and correct delivery instructions to the clearing bank, the bank does not deliver the security. Furthermore, the seller is not paid until this "failed delivery" is rectified. Since the purchase price is not changed, these "fails" generate interest-free loans from the seller to the buyer. This article studies the effect of failed delivery on Treasury bill prices. We find that investors bid prices to a premium to reflect the possibility of obtaining the interest-free loans that fails represent. This premium is a function of the opportunity cost of the fail. We also find that the bid-ask spread varies directly with the length of the fail. We rule out that our results are due to liquidity premiums, or to a general weekly pattern in short-term interest rates or the bid-ask spread.

Keywords: fails, failed delivery, bid-ask spread

JEL Classification: G12, G20, G21, G24

Accepted Paper Series