Green Bond Premiums in Segmented Markets Reveal Market Inefficiencies

Green bond premium (greenium) exists for bonds that direct proceedings toward ‘green’-purposes. To reduce the adverse selection problem due to greenwashing, certification is required. Henide (2022) presents a convincing argument that certification costs are a function of greenium. In current practice, certification costs are at a flat rate, but in an efficient market this is only attainable at a constant greenium level. This paper explores variation in greenium when segmenting green bond markets. As such, we estimate mixed effects models by looking at credit risk and ‘Use-of-Proceeds’ categories. Outcomes are that lower-rated bond categories, on average, have higher greenium levels, while there is also a significant difference in the variance between ‘Use-of-Proceeds’ categories. Given the current certification practice, categorization of green bonds reveals market inefficiencies, which may harm the green transition in certain categories. We expect reduced inefficiencies due to standardised taxonomies, as these allow differential certification costs.