Green bonds are a relatively new financial instrument that may facilitate the energy transition. These instruments can be issued by governments, supranational and government-related institutions or corporate entities. The issuance of green bonds is typically tied to specific green projects designed to avoid or reduce climate change, such as renewable energy projects that facilitate the energy transition away from fossil fuels.
A research question that has not yet been addressed in the academic literature on green bonds is the place of green bond investments in an overall fixed income portfolio. This research question is challenging for two reasons.
Firstly, since the market has seen a rapid development over the past years, historical data may not be representative for future risk and return characteristics. Secondly, the green bond market has different characteristics from a typical fixed income benchmark, as it has a different credit rating, currency, sector, and maturity composition.
Our empirical analysis shows that the green bond market is predominantly a market with bond issues denominated in euro and with less credit risk than a corporate bond portfolio. The sector composition is also tilted to government-related securities and includes emerging markets issuers.
An analysis of the data shows that returns data for green bonds going back to 2010 may not be representative for the future. The number of green bonds was limited in the early days, making idiosyncratic risk much more important in the early part of the sample period. In addition, the composition on the dimensions rating, currency, sector and maturity has changed considerably over time. Using returns data prior to the launch date of the green bonds index in October 2014 is therefore unlikely to help to better understand future risk and return of green bonds.
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