Green Bonds Pay When Trustworthy

Abstract

Green bonds are a form of bonds whose proceeds should be exclusively used for green projects. The green bond premium or greenium is the difference in yield between a green bond and the otherwise-identical brown bond. We propose a stylized model in which the size of the premium is affected by investors' trust in the issuer using green bond proceeds responsibly and the market's expectations of the issuer's financial soundness. Using a matching method to compare bond yields at the time of issuance, our empirical analysis offers three novel findings in line with the predictions of our model. First, green bonds save funding costs compared to their brown counterparts. Second, the green bond premium is more negative - indicating less funding costs - for firms exposed to higher carbon transition risk and stronger management capabilities in this area. Last, the green bond premium is more negative for non-investment grade bonds.

Keywords: green bond, cost of funding, green premium, transition risk

JEL Classification: G12, G41, Q54