What does it cost to be green? : An empirical investigation of the European green bond market

Abstract: The green bond market offers investors the opportunity to take an explicit focus on sustainable investment projects. However, it is yet to be determined whether this novel asset class offers attractive yields compared to non-green bonds. To address this question, we study European green bonds and how they diverge from conventional bonds in terms of yields. Using a dataset of 88 matched pairs of European green bonds between 2015 and 2019, we document a significant negative green bond premium of -12 bps on average in the secondary market. The green bond premium is defined as the yield differential between a green and a conventional bond while controlling for liquidity. The results suggest that European investors accept a lower financial return in exchange for receiving non-pecuniary benefits and thus challenging the assumptions of classical asset pricing models. Furthermore, we use a matching method and two-step regression to control for liquidity and identify the determinants of the green bond premium. The results show that the negative green bond premium is less pronounced for lower-rated bonds. Moreover, we find support for variations in the green bond premium across different business sectors. Government-related green bonds experience a greater negative green bond premium than green bonds related to financials and industrial corporates.