New Time-Dependent Risk–Return Trade-offs from CBI-Certified Municipal Bonds

Abstract

Forced to address human-induced climate change, the world has embarked on the transition to a low-carbon economy, requiring massive amounts of financing. Municipalities in the US have begun to issue bonds that are third-party certified and registered with the Climate Bonds Initiative (CBI) to attract funding for much-needed climate-related infrastructure. As this market is developing, borrowers and lenders are assessing the potential for new risk–return trade-offs over time. Variations in the pricing of CBI-certified municipal bonds with different terms to maturity likely depend on the extent to which climate-related projects are expected to be prioritized in fund allocations to correspond to increases in public attention to the dynamics of climate change. As the pricing of time-dependent climate-related risks progresses, the market for CBI-certified bonds promises to become an efficient funding mechanism for communities grappling with climate risks while expanding the menu of risk–return choices for investors. TOPICS:ESG investing, risk management, fixed-income portfolio management Key Findings • The yields of municipal bonds that are certified to address the risks associated with climate change appear to decline relative to the yields of comparable conventional bonds with lengthening maturities. • The dynamic nature of the climate risks and the public’s growing willingness to prioritize climate-related projects are likely factors in the bonds’ time-dependent pricing. • This emerging market segment may develop into a valuable funding mechanism for climate-conscious municipalities while expanding the menu of risk–return opportunities for investors.