Green Bonds: A Study on Expected Returns and Liquidity Effects

Abstract: The emerging market of Green bonds has seen a positive growth over the recent years in the presence of the Paris objective of limiting the global warming to 2°C by the year 2100. In addition, fuelled the attention from a broader audience of issuers and investors. Although the demand for Green bonds has strongly increased in popularity over the recent years, the supply only represents a small percentage of the total global bond market. This implies a disequilibrium on the Green bond market and the notions of a narrow market were a liquidity premium most likely exists. However, limited empirical research has been conducted on liquidity and financial returns of Green bonds in the past. The thesis therefore investigated whether the liquidity premium had an effect on Green bond expected returns on the global market. The thesis is based on a dataset of 379 Green Bonds over the time period between 2014 and 2018 with the use of an extended Fama and French pricing model in a fixed effects regressions procedure. As a liquidity measure, the thesis employed the bid-ask spread and found that the measure positively influences expected returns for Green bonds. Even after controlling for characteristics such as age, currency, public listed equity, credit rating and initial issued amount the positive effect still remains. This can be interpreted that investors want to be compensated from bearing the liquidity exposure, hence a positive effect on the Green bond expected price returns. The findings could potentially reduce the information asymmetry and lower the transaction cost on the market for Green bonds, as both issuers and investors can address the liquidity exposure accordingly. Consequently, achieve a better mean of funding future Green projects that potentially have a positive environmental and climate outcome that aligns with the Paris objective.