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

A substantial increase of green investments is still required to reach the Paris Agreement’s emission targets. Yet, capital markets to expedite innovative 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 bond 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 these 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). Our model reveals that de-risked interest rates, from the cost side, and mark-ups and profit flows, from the market side, improve new entrants’ performance. As innovators normally have low mark-ups, inducing higher profit flows and lower capital costs allows a better default risk control and debt repayment which keep the firms in the market for a longer period of time and maintain low debt levels. Subsidies and carbon taxation can complement the role of the de-risked interest rate and expedite the energy transition.