On a Trajectory to Sustainable Investing: A Study of the Pricing, Performance, and Characteristics of Green Bonds

Abstract

In recent years, green bonds have become a popular sustainable financing instrument, driving this thesis to analyse green bond characteristics to identify the effect of non-pecuniary investor motives on green bond pricing and performance. While an array of scholars has investigated the primary green bond market and revealed the notion of a ‘green premium’, the secondary market remains more unexplored given its previous immaturity and low liquidity, causing challenges related to data availability. Therefore, this thesis attempts to bridge this gap in the literature by examining whether a green premium exists in the secondary green bond market, what the drivers of a potential pricing differential are, and to what extent green bonds should be considered a separate asset class when making investment decisions.
This thesis applies a matching methodology to compare the interest-rate adjusted yields of green and otherwise similar conventional bonds from 2018 to 2022. A Wilcoxon signed-rank test suggests the existence of a green premium in the secondary market by showing that investors, on average, have been willing to accept a ~1.3 bps lower yield on green bonds. Further-more, a fixed-effects panel regression indicates that the green premium varies significantly across bond indenture characteristics, credit ratings, issuer types, liquidity scores, and ESG ratings, hence suggesting that traditional bond pricing fundamentals, as well as the attributed ‘greenness’ of the bond, proxied by the issuers’ ESG score, collectively determine investors’ willingness to pay a premium. Moreover, taking an investor perspective to derive potential diversification and hedging benefits of green bonds relative to other asset classes, correlation matrices and return volatilities are found to indicate (i) negligible diversification benefits for investors in conventional bonds but some benefits for stock and commodity investors and (ii) no particular green bond ‘safe haven’ as green and conventional bonds reacted comparably to recent market setbacks.
To nuance these findings, interviews are conducted with green bond issuers, investors, and advisors. Their perspectives are included in the analyses and discussion, ultimately enabling a more granular and refined examination. Finally, based on both the qualitative and quantitative evidence, an assessment matrix ranking the relative importance of different green premium drivers is created by the authors of this thesis in an attempt to bridge the aforementioned gap in the current literature. For practitioners, this matrix can serve as a valuable tool for evaluating green bond investment decisions.