De-risking of Green Investments through a Green Bond Market – Empirics and a Dynamic Model

Braga, J.P., Semmler, W., & Grass, D. (2020). De-risking of Green Investments through a Green Bond Market – Empirics and a Dynamic Model. IIASA Working Paper. Laxenburg, Austria: WP-20-014

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Abstract

A substantial increase of green investments is still required to reach the Paris Agreement’s emission targets. Yet, capital markets to expedite green invest-ments are generically constrained. Literature has shown that governments could de-risk such investments. Empirical beta pricing and yield estimates reveal some public involvement in the green bonds market, especially for long ma-turity bonds. We provide empirical evidence that Governments and Multilateral organizations can de-risk green investments by supporting the issuance of green bonds in contrast to private green bonds - that show higher yields, volatility and beta prices - and conventional energy bonds, that are more volatile due to oil price variations. Since lower betas also mean lower capital costs, we use those empirical results and run a dynamic model with two types of firms, modeling the economic behavior of innovators (renewable energy firms) and incumbents (fos-sil fuel firms). The simulations of our model show that de-risked interest rates help to phase in renewable energy firms in the market and avoid a sharp debt increase. However, when the new entrants carry negative pay-offs for a longer time, it might not be sufficient to keep the debt low and to avoid a shake-out in the market. Subsidies and carbon taxation can complement the role of the de-risked interest rates and expedite the energy transition. Beside deterministic model variants, we also explore a stochastic version of the model.

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