De-risking of green investments through a green bond market – Empirics and a dynamic model

Abstract

A substantial increase of green investments is still required to reach the Paris Agreement's emission targets. Yet, capital markets to expedite green investments 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 maturity 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 (fossil 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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