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Financing Climate Action: The Pricing of Green Bonds and Its Determinants
Thesis title in Czech: Financování boje proti změně klimatu: Cena zelených dluhopisů a její detereminanty
Thesis title in English: Financing Climate Action: The Pricing of Green Bonds and Its Determinants
Key words: zelené dluhopisy, zelená prémie, udržitelné investice, preference investorů
English key words: green bonds, green premium, sustainable investments, investors' preferences
Academic year of topic announcement: 2018/2019
Thesis type: diploma thesis
Thesis language: angličtina
Department: Institute of Economic Studies (23-IES)
Supervisor: prof. Ing. Evžen Kočenda, M.A., Ph.D., DSc.
Author: hidden - assigned by the advisor
Date of registration: 22.05.2019
Date of assignment: 22.05.2019
Date and time of defence: 15.09.2020 09:00
Venue of defence: Opletalova - Opletalova 26, O206, Opletalova - místn. č. 206
Date of electronic submission:24.07.2020
Date of proceeded defence: 15.09.2020
Opponents: prof. PhDr. Petr Teplý, Ph.D.
URKUND check:
Baker, M.P., Bergstresser D., Serafeim G. & Wurgler G., 2018. Financing the Response to Climate Change: The Pricing and Ownership of U.S. Green Bonds. NBER Working Paper No. 25194.
Climate Bonds Initiative, 2018. Green Bond Pricing in the Primary Market: July-September 2017.
Climate Bonds Initiative, 2019. 2018 Green Bond Market Summary.
Ehlers, T. & Packer, F., 2017. Green bond finance and certification. BIS Quarterly Review, 2017, 89-104.
Fatica, S., Panzica, R. & Rancan, M., 2019. The pricing of green bonds: are financial institutions special?. In Luxembourg: Publications Office of the European Union.
Hachenberg, B. & Schiereck, 2018. Are green bonds priced differently from conventional bonds?. Journal of Asset Management, 2018(19), 371-383.
Kapraun, J. & Scheins, Ch., 2019. (In)-Credibly Green: Which Bonds Trade at a Green Bond Premium?.
Karpf, A. & Mandel, A., 2018. The changing value of the `green' label on the US municipal bond market. Nature Climate Change, 2018(8), 161-165.
Lewis, J.B. & Linzer, D.A., 2005. Estimating Regression Models in Which the Dependent Variable Is Based on Estimates. Political Analysis, 13(4), pp.345-364.
Stuart, E.A., 2010. Matching Methods for Causal Inference: A Review and a Look Forward. Statistical Science, 25(1), 1-21.
Zerbib, O.D., 2019. Is There a Green Bond Premium? The yield differential between green and conventional bonds. Journal of Banking and Finance, 2019(98), 39-60.
Preliminary scope of work in English
During recent years, increasing awareness of the need to take action and actively fight climate change has attracted the attention of both investors and bond issuers towards the green bond market. Green bonds are innovative fixed-income financial instruments that differ from conventional bonds in terms of use of proceeds as finance raised can be applied exclusively to projects with clear environmental benefits ("greenness"). Since the issuance of the first green-labeled bond by the European Investment Bank in 2007, the green bond market has been experiencing rapid growth, with the total global issuance reaching US$167.3 billion in 2018 (Climate Bonds Initiative, 2019). In comparison to only four years ago, when US$42 billion in green bonds were sold during 2015, the green bond market has proven increasingly popular and as a result, continued becoming more mature and diversified.

Despite the exponential growth during recent years, there is still substantial potential for the green bond market's future development, as long as sustainability issues and climate change mitigation remain global priorities. Bearing in mind their pledge to shift economies into climate-resilient and low-emission, governments need financial resources for infrastructure investments required under the Paris Agreement and 2030 Agenda for Sustainable Development. At the same time, green bonds issuance is of interest to corporations as well, since tightening ecological standards and regulations put firms under pressure to prove as environmentally responsible. There is a strong need for the private sector to take part in the environmental transition and supplement funding that is necessary to close the investment gap for climate change mitigation and adaptation plans.

In order to direct capital flows into green projects and ensure further development of the green bond market, it is crucial to evaluate the pricing of green bonds and understand its underlying characteristics. There has been a limited number of studies examining the existence of a green premium. Green premium, also called the "greenium", is the difference between the yield on a green bond and otherwise identical conventional bond. Existing works on the pricing of green bonds vary widely in terms of the type of data used, selected time frame, geographical coverage, as well as research methodology employed. Subsequently, empirical results do not reveal any unequivocal conclusion on the relative pricing of green bonds with respect to conventional bonds. The majority of recent studies find evidence that green bond issuers borrow at lower rates than they would have through conventional bonds (e.g. Ehlers & Packer, 2017; Hachenberg & Schiereck, 2018; Zerbib, 2019). However, the magnitude of the estimated negative premia varies widely. Conversely, in a study of the premium on municipal bonds in the secondary market, Karpf & Mandel (2018) find a positive premium. The study produced by the Climate Bonds Initiative (2018) on the yield differential between green and conventional bonds at issuance claims that there is no significant difference in the primary market.

This thesis aims to exploit the momentum of the fast-growing green bond market and the increased availability of data to follow up on previous research. The ultimate goal is to study the yield differential between green and conventional bonds in the secondary market and examine if premium found in previous studies prevails in the market. Furthermore, the characteristics of green bonds and their issuers will be analyzed to find out what are the main determinants of the yield differential.

Hypothesis 1: There does not exist a negative premium on green bonds in comparison to otherwise identical conventional bonds in the secondary market.
Hypothesis 2: The green premium does not vary with green-related characteristics of issued bonds.
Hypothesis 3: The green premium does not vary with the characteristics of the bond issuer.

The dataset will be retrieved from Thomson Reuters Eikon as bonds with the label green. The database provides detailed information on the bonds and their issuers. Furthermore, additional information on the bonds will be retrieved from the Climate Bonds Initiative which covers green bond issuance since 2007.

A matching method, used in the financial literature as a preferred technique to assess the intrinsic value of a specialized instrument, will be utilized to estimate the yield differential between green and equivalent conventional bonds. In the first step, treated and control groups will be identified. Green bonds will constitute the treated group and conventional bonds the control group. Based on the approach introduced by Zerbib (2019), two conventional bonds will be matched with one green bond, and triplets of securities with similar characteristics except for the one of interest ("greenness") will be created. An important step involves determining which bond characteristics must be an exact match. Following previous research (e.g. Hachenberg & Schiereck, 2018; Zerbib, 2019), variables with exact match will include the type of issuer, currency, rating, bond structure, seniority, collateral and coupon type. The difference in maturity and liquidity between green and conventional bonds is also desired to be as small as possible and will be constrained to ensure that no large deviations affecting the yield level occur.

Following Zerbib (2019), once the panel of triplets of green and conventional bonds is composed, the daily ask yields will be retrieved. A synthetic conventional bond will be constructed so that its maturity matches that of the green bond. Then, the yield spread between the securities will be computed. The next step will involve the estimation of the green premium through fixed effects panel regression of the yield spread on the bonds' difference in liquidity. The green premium will be captured by the unobserved specific effect. In contrast to many previous studies, such an approach will enable to control for liquidity differential between each green bond and corresponding conventional bond.

Finally, in order to test hypotheses concerning the determinants of the green premium, a linear regression of the estimated green premium on bond characteristics will be run. It is important to note that as the dependent variable is an estimate produced in the first stage of the analysis, the variation in the sampling variance of the observations will induce heteroskedasticity (Lewis & Linzer, 2005). To deal with this issue, Weighted Least Squares estimation will be employed. In this stage, we will examine if there is a variation in the magnitude of the green premium with bond characteristics such as issue amount, currency, rating, and maturity. Furthermore, this part of the analysis will try to give answers to questions: a) Do green bonds that signal higher credibility of greenness enjoy pricing benefits?; b) Does the issuer's environmental profile play role in the pricing of issued green bonds?; c) Is better reputation of the issuer associated with higher pricing?

The green bond market is considered as a critical instrument for funding the investments needed to achieve goals set by the international environmental agreements. To sustain the fast pace of the green bonds' growth and development, it is vital to explain the concerns of prospective investors, one of them being their pricing. Therefore, this master's thesis aims to expand the existing research of the green bond market by examining the existence of a green bond premium in the secondary market. As the existing literature aiming to explain the pricing of green bonds is limited and empirical results are mixed, this work will contribute to the current discussion by utilizing the increasing availability of data and analyzing the up-to-date global green bond universe. An empirical model similar to the one used by Zerbib (2019) will be employed in order to estimate the difference in the pricing of green and otherwise similar conventional bonds. Next, the contribution within the existing research lies in the subsequent analysis and identification of factors that influence the pricing of green bonds. Specifically, it will be examined if the magnitude of the green premium varies with the "greenness" of the issuer and the green bond's credibility and transparency.

The evaluation of the greenness and its determinants is crucial for the future growth of the green bond market and for ensuring that capital necessary for ambitious environmental goals is secured. The results obtained in this thesis will be of great interest to all involved parties. The finding that green bonds are priced in line with conventional bonds is the key to enhance investors' interest in environment-related projects. Such a result would enable to further diversify the investor base as not only environmentally responsible investors would find green bonds appealing. However, the small negative premium would not necessarily jeopardize investors' interest but would present an opportunity for issuers to take advantage of the pricing advantage.

1. Introduction
2. Motivation
3. Literature Review
4. Hypotheses Development
5. Data and Sample Construction
6. Empirical Framework
7. Results
8. Discussion of Results
9. Conclusion
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