Extreme Connectedness between Green Bonds, Government Bonds, Corporate Bonds and Other Asset Classes: Insights for Portfolio Investors

Abstract

This paper aims to examine the connectedness between green and conventional assets, particularly during the period of economic downturn. Specifically, we examine quantile-based time-varying connectedness between the green bond market and other financial assets using quantile vector autoregression (QVAR) from 9 March 2018 to 10 March 2021. We use daily prices of S&P U.S. Treasury Bond Index, S&P US Aggregate Bond Index, S&P US Treasury Bond Current 10Y Index, S&P 500 Bond Index, S&P 500 Financials index, S&P 500 Energy Bond Index and S&P 500, giving a total of 784 observations, and using Composite Index as a representative of conventional assets classes and S&P Green Bond Index to denote the green bond market. Results shows the connectedness between green bonds and the conventional asset classes intensified during the outbreak of the Coronavirus pandemic (COVID-19) as investors shifted their investment towards fixed income assets due to the plunge in the prices of stocks and commodities. The results also shows that green bonds are strongly connected with treasury bonds, aggregate bonds and bond index, as they share similarities with respect to issuance, risk and governance. Connectedness is weak in the case of composite index and energy bond index, as their prices do not have substantial influence on the green bond market. The study highlights the hedging and diversification benefits of green bonds. We have several implications for portfolio managers, policy makers and researchers.

Sovereign Green Bond Market: Drivers of Yields and Liquidity

“…A negative relationship between conventional sovereign bond returns and the YTM of green bonds suggests that green bonds tend to offer higher yields or become relatively more attractive compared to conventional bonds during periods of declining conventional bond returns. For example, Abakah et al (2022) study showed a strong connectedness between green bonds and conventional sovereign bonds, particularly during economic downturns. The connection between conventional and green bonds is multifaceted and influenced by various factors such as the bond rating and issuing currency (González-Fernández and González-Velasco 2018).…”