Financing the Response to Climate Change: The Pricing and Ownership of US Green Bonds

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Estimates suggest that mitigating and adapting to climate change will cost trillions of dollars. We study the developing market for green bonds, which are bonds whose proceeds are used for environmentally sensitive purposes. After an overview of the U.S. corporate and municipal green bonds market, we study pricing and ownership patterns of municipal green bonds using a framework that incorporates assets with nonpecuniary sources of utility. The results support the prediction that green bonds are issued at a premium to otherwise similar ordinary bonds—that is, with lower yields—on an after-tax basis. They also support the prediction that green bonds are more closely held than ordinary bonds, particularly small or essentially riskless green bonds. Both pricing and ownership effects are stronger for bonds that are externally certified as green

Climate change is accelerating. Of the seventeen warmest measured years since recordkeeping began in 1880, sixteen have occurred since 2001.1 The rising temperature and increasing acidity of ocean water, climbing sea levels and the retreat of ice sheets and glaciers, and the increasing frequency of droughts and floods all reflect a changing climate and increasing atmospheric carbon levels.2 One estimate suggests that keeping the world below the 2 degree Celsius scenario, a threshold viewed as limiting the probability of devastating consequences, will require $12 trillion over the next 25 years (Bloomberg New Energy Finance, 2015). In the absence of a massive carbon tax scheme, bond markets will be central to financing these interventions. In this paper, we study the U.S. market for “green bonds,” which we and others define as bonds whose proceeds are used for an environmentally friendly purpose. Examples include renewable energy, clean transportation, sustainable agriculture and forestry, energy efficiency, or biodiversity conservation. After reviewing the market and green bond characteristics, we set out and test predictions for pricing and ownership patterns. The stark facts of climate change alone are enough to motivate study of green bonds, but our framework and results also tie to broader themes in the socially responsible investing literature. Since the first green bond was issued in 2007 by the European Investment Bank, the market has expanded to include a variety of issuers, including supranationals, sovereigns, corporations, and U.S. and international municipalities. It is a small but increasingly well-defined area of the fixed income markets. Yet in spite of the general acceptance of the notion of a “green” bond, there is not yet a single universally-recognized system for determining the green status of a bond. Green bonds may be labeled and promoted as such by the issuer, officially

certified by a third party according to some guidelines, or labeled green by a data provider, for example Bloomberg. We review the origins of the market and standards for identifying green bonds in the next section.