Investigation of the long-run indirect relationship between environmental policy stringency and green bonds via green innovation

This study examines the non-linear relationship between environmental policy stringency (EPS) and green innovation (GI), and its impact on the green bond market, measured by the S&P Green Bond Index (GBI) and iBoxx Global Green Bonds Select Index. Using monthly data from 2014 to 2024 and an autoregressive distributed lag-error correction mechanism model, we find an inverted U-shaped relationship where moderate EPS fosters GI but excessive stringency hinders it. The optimal EPS level for maximizing GI is approximately 133—an indicative benchmark rather than a prescriptive policy target—suggesting that current global policy stringency (averaging 89) still falls within an innovation-enhancing range. Mitigation-related policies exhibit higher thresholds than adaptation-focused measures, emphasizing the need for balanced strategies. Results also reveal that while moderate EPS strengthens the positive impact of GI on GBI, overly stringent policies constrain this relationship. Rising interest rates negatively affect green bonds, highlighting sensitivity to macroeconomic conditions. These findings provide critical insights for designing effective environmental regulations that stimulate innovation while avoiding over-regulation, ultimately supporting sustainable finance and climate goals.