Green Bond Premiums in Segmented Markets Reveal Market Inefficiencies

Financial markets that include a green bond premium (greenium) in prices signal there is support for investments in a green transition. For example, the greenium absorbs costs associated with green bond certification, which is necessary to prevent greenwashing. To reduce uncertainty about green bonds, different organizations develop different green taxonomies. These taxonomies differentiate the level of greenium on various aspects. Variation in greenium across different bond classes not only suggests that the charges of green bond certification should differ, but also reveals differences in the way markets assess distinctive classes of green bonds. Especially, if bond classifications are subject to change or categories are ambiguous this will result in market inefficiencies. This study attempts to assess the potential severity of such issues with the green taxonomy. We compare 858 pairs of matched green and non-green bonds and use a mixed effects model to estimate the effects of distinct groups of bonds that are overlapping with green taxonomy categories. More specifically, our results show that greenium levels differ significantly over credit ratings and ‘Use of Proceeds’ categories. Lower-rated bonds reach, on average, higher greenium levels, controlling for categorical random effects. Our results imply market inefficiencies due to segmentation since, in current practice, certification costs are mostly flat and independent from greenium levels. Counterintuitively, creating a green taxonomy could lead to more uncertainty and adverse selection of “true” green project financing. This could delay the green transition and the shift to a low-carbon economy.