Abstract
The green bond market is emerging as an impactful financing mechanism in climate change mitigation efforts. The effectiveness of the financial market for this transition to a low-carbon economy depends on attracting investors and removing financial market roadblocks. This paper investigates the differential bond performance of green vs non-green bonds with (1) a dynamic portfolio model that integrates negative as well as positive externality effects and via (2) econometric analyses of aggregate green bond and corporate energy time-series indices; as well as a cross-sectional set of individual bonds issued between 1 January 2017, and 1 October 2020. The asset pricing model demonstrates that, in the long-run, the positive externalities of green bonds benefit the economy through positive social returns. We use a deterministic and a stochastic version of the dynamic portfolio approach to obtain model-driven results and evaluate those through our empirical evidence using harmonic estimations. The econometric analysis of this study focuses on volatility and the risk–return performance (Sharpe ratio) of green and non-green bonds, and extends recent econometric studies that focused on yield differentials of green and non-green bonds. A modified Sharpe ratio analysis, cross-sectional methods, harmonic estimations, bond pairing estimations, as well as regression tree methodology, indicate that green bonds tend to show lower volatility and deliver superior Sharpe ratios (while the evidence for green premia is mixed). As a result, green bond investment can protect investors and portfolios from oil price and business cycle fluctuations, and stabilize portfolio returns and volatility. Policymakers are encouraged to make use of the financial benefits of green instruments and increase the financial flows towards sustainable economic activities to accelerate a low-carbon transition.
Highlights
Sustainable economic growth entails changes in production, consumption and, in the form of financing “green investment”
We use a fast Fourier transform (FFT)—as in Chiarella et al (2016) and Semmler and Hsiao (2011)—to empirically estimate the harmonic oscillations of the monthly annual total returns for green and fossil fuel bonds, based on two market indices provided by Bloomberg Barclays MSCI5 and that are available from December 2015 to December
Reproducible code from the authors is available upon request
Summary
Sustainable economic growth entails changes in production, consumption and, in the form of financing “green investment”. The theoretical part includes a generic model of asset pricing and dynamic portfolio decisions concerning the shift from brown to green investments by including positive and Econometrics 2022, 10, 11. What has not been studied sufficiently are the positive and negative feedback effects, arising on the real side of the economy, impacting the asset pricing, financial returns, and portfolio decisions of investors. There are studies on the green and conventional (and fossil fuel-based) bonds and how those asset returns and volatility are impacted by disaster or fuel price shocks.. This work contributes to the existing literature by providing a dynamic portfolio model adjusted to account for climate externalities, and by relying on both endogenous growth theory and real data from the financial market performance of green and fossil fuel bonds.
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