Does the US Government Hedge against Government Expenditure Risk?

Standard theory prescribes that the government hedge against shocks to its expenditures by generating total debt portfolio returns with a negative beta on government expenditure innovations. This paper asseses how well the government manages its debt portfolio against the benchmark government debt beta generated in a Ramsey economy. We identify exogenous innovations to government expenditures using standard VAR methodology and compute the beta of total government debt returns with respect to these government expenditure innovations. In addition, we conduct an event study by identifying exogenous events that signal a shock to the US government's expenditure process and compute the abnormal returns on the government's debt portfolio around these events. We use the stock returns for firms in the defense industry and the returns for other government contractors to extract information about the size and persistence of the shocks to government expenditures. Finally, we conclude by linking the US total debt portfolio beta to the government debt betas on different maturities. This allows us to make inference about the optimal state-dependent maturity composition.