Green dreams, risky assets? A study of high-yield green bonds

Abstract

High-yield green bonds are corporate bonds rated BB+ or below, specifically designated to finance environmentally friendly projects. The market for these bonds is approximately one-fifth the size of the investment-grade green bond market and has been steadily growing. However, this segment has received little attention in the literature. In this study, we make the first attempt to examine the pricing of high-yield green bonds, both theoretically and empirically. We propose a novel economic model in which the credit spread of high-yield green bonds depends not only on the probability of financial success, but also on the environmental success probability of the projects financed by the bond and the investor's willingness to trade financial return for environmental return. The credit spread of a high-yield green bond can be lower than that of a conventional (or brown) bond only if some investors have confidence in the issuer's ability to deliver environmental value by successfully implementing green projects. Empirically, we investigate whether such a negative wedge between green and brown credit spreads exists in the high-yield bond market, using a standard matching methodology. We find that the mean credit spread of high-yield green bonds is lower than that of their brown counterparts, although the difference is not statistically significant.