Abstract: In this paper, we study the benchmark greenium, the frictionless premium of sovereign
risk-free green securities relative to otherwise identical non-green securities. Identifying this type of greenium is important for two reasons. First, since sovereign green bonds are not project-specific, in the absence of market frictions, our greenium will capture the shadow value of wide environmental concerns. Second, because bids in the primary auction market depend largely on resale prices in the secondary market, the benchmark greenium provides a signal about future savings from the issuance of green securities.
Exploiting the unique ``twin'' structure of German government green and conventional securities, we use a dynamic term structure model to estimate a frictionless sovereign risk-free greenium, distinct from the yield spread between the green security and its conventional twin (the green spread). The model purifies the green spread from confounding and idiosyncratic factors unrelated to environmental concerns.
We have three main findings. First, the model-implied benchmark greenium differs substantially from the observed green spread: it tends to be significantly larger; at times it
widens while the green spread narrows; and its term structure is mostly flat, rather than
downward-sloping. Second, proxies of confounding and idiosyncratic risk factors, such as
stock market prices, measures of flight-to-quality, and liquidity, do not affect the model-
implied greenium, but do correlate with the green spread. Conversely, the benchmark greenium correlates with shocks to environmental concerns, such as the economic damages from environmental disasters. Interestingly, once we control for confounding and idiosyncratic risk factors, the green spread does not correlate significantly with shocks to environmental concerns. Third, the difference between the expected return on green and conventional bonds, the expected green excess return, varies with the investment horizon and investors’ information set: it is positive at issuance and turns negative after the German floods.
Our findings are important not only because they indicate that green spreads should not
be taken at their face value to price environmental concerns, but also due to their policy
implications. First, the fact that the benchmark greenium is not reverting to zero over
time signals that green security issuance can provide interest cost savings to governments. However, to access these savings, government finance agencies need to minimize market
frictions. Second, a persistent benchmark greenium justifies the inclusion of green assets by central banks in the conduct of conventional and unconventional monetary policy, since it indicates investors’ preference for green investments, and eligibility for central bank
operations reduces liquidity risks and other frictions affecting these assets, especially in
periods of crisis. Third, a risk-free benchmark greenium will allow for more efficient pricing
of private green securities, strengthening the market for green investments.
Discussant: Peter Feldhütter, Copenhagen Business School
Abstract: Climate capitalists invest in green firms in order to lower these firms’ cost of
capital and thereby stimulate green investments. This "green investing" channel
only works if green firms actually reduce their perceived cost of capital and
discount rates in response to green investing. We use hand-collected data on
firm perceptions and discount rates. We find that the average difference in the
perceived cost of capital between the greenest and the brownest firms was close
to zero before 2016 but has fallen to -2.6 percentage points in the years since
2016, concurrent with the rise of green investing. Similarly, the difference in
discount rates was small before 2016 and has fallen to -5.8 percentage points
since 2016. In a simple stylized model, the observed differences in discount
rates are large enough to reduce firm-level emissions by 20 percent. We survey
corporate managers to study how firms incorporate greenness into their discount
rates. Overall, the results are consistent with an important role for climate
capitalists in stimulating climate-friendly production.
Discussant: Aymeric Bellon, University of North Carolina-Chapel Hill
Abstract: We build a general equilibrium model to study how climate transition risks affect energy prices. Fossil fuel firms have existing capacity, but their technology to produce energy entails carbon emissions. Renewable energy firms produce energy without generating carbon emission but cannot currently supply to non-electrifiable sectors of the economy. We consider two sources of climate transition risk for fossil fuel firms: (i) the possibility of a technological breakthrough that improves renewable energy firms' ability to provide energy to all sectors, and (ii) the introduction of taxes on carbon emissions and new fossil fuel production capacity. Such transition risks make it less attractive for fossil fuel firms to create new capacity that might get stranded in the future. However, if breakthrough technologies do not arrive, this reduced capacity will lead to higher energy prices, in particular for non-electrifiable sectors. This, in turn, can create incentives for incumbent fossil fuel firms to carry existing inventories to the future, reducing supply and raising prices today. We show how an optimally implemented tax policy, which sets a lower carbon tax and a higher tax on new fossil fuel production capacity as the green transition becomes more likely, can mitigate the risk of higher energy prices while maximizing social welfare. We present several testable implications based on this counterintuitive effect of transition risk on energy prices and provide preliminary empirical support.
Discussant: Deeksha Gupta, Johns Hopkins University
Quentin Moreau, Hong Kong University of Science and Technology
Abstract: This paper introduces a novel market-based framework to study the effects of tail climate risks in the financial sector. Beyond identifying financial institutions most vulnerable to physical and transition climate risks, our framework explores the potential for these risks to induce contagion effects within the financial sector. Based on the securities of large European financial institutions spanning 2005 to 2022, we show that, unlike physical risks, transition risks significantly and increasingly influence systemic risk in the financial sector. We find that financial institutions with cleaner investment and lending portfolios and with a long-term
orientation exhibit lower exposure to transition risks, providing valuable guidance to financial institutions and regulators in addressing climate-related financial risks.
Discussant: Hyeyoon Jung, Federal Reserve Bank of New York
