Green Bond Risk Premiums: A Twin-Bond ULFP Approach

32 Pages Posted: 7 Jul 2020

See all articles by Ulf Erlandsson

Ulf Erlandsson

Anthropocene Fixed Income Institute; Knut Wicksell Centre for Financial Studies

Date Written: May 20, 2020

Abstract

This paper explores the risk premium in green bonds and how it relates to the more frequently researched spread premium. The approach can reconcile the inherent conflict between issuers and investors in green bond markets where one basis point of spread premium gained for the issuer of a bond is one basis point lost for the investor. We illustrate that when green bonds trade with lower volatility than traditional bonds, issuers can issue greens at a lower cost-of-capital while at the same time investors can remain within their fiduciary duty limits if expected risk-return ratios do not deteriorate. Thus our understanding of bond spreads' statistical properties becomes important: using the Unibail-Rodamco (ULFP) bond curve with near identical twin bonds, we build a laboratory of sorts which allows for quite specific like-for-like analysis and avoids potential curve mis-specification. We explore how to use various econometric techniques including cointegration and time-varying volatility to arrive at conclusions both for absolute spread premiums as well as relative volatility between green and traditional bonds. This should be useful both for how to price bonds when issued into primary markets, as well as a support to evaluate secondary market pricing of already issued bonds. It also highlights the role volatility reductive measures from policy institutions could play to support lower cost-of-capital for green investment projects.

Keywords: Green bonds, pricing, risk premium

JEL Classification: G12, Q54

Suggested Citation

Erlandsson, Ulf, Green Bond Risk Premiums: A Twin-Bond ULFP Approach (May 20, 2020). Available at SSRN: https://ssrn.com/abstract=3624591 or http://dx.doi.org/10.2139/ssrn.3624591

Ulf Erlandsson (Contact Author)

Anthropocene Fixed Income Institute ( email )

c/o Erlandsson
Fogdev 4
Saltsjo-Duvnas, NA 13150
Sweden

HOME PAGE: http://www.anthropocenefii.org

Knut Wicksell Centre for Financial Studies ( email )

Box 7080
Lund, SE-220 07
Sweden

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