Financing environmentally-sustainable projects with green bonds

Abstract A structural model for green bonds is developed to explain the formation and dynamics of green bond prices and to address the issue of the so-called ‘greenium’, that is, the difference between the yields on a conventional bond and a green bond with the same characteristics. We provide answers to the following questions: What are the determinants of the green bond value? Do green bonds enhance the credit quality of the issuer? Are green bonds a relatively cheap tool to fund sustainable investments? We also study the effect of investors' environmental concern on portfolio allocation. Our results have direct policy implications and suggest that an improvement in credit quality could ultimately lead to a lower cost of capital for green bond issuers and that governmental tax-based incentives and an increase in investors' green awareness play a significant role in scaling up the green bonds market.