Volatility Risk, Climate Risk and Green Corporate Bond Pricing in Greece

ABSTRACT This study investigates the influence of idiosyncratic volatility, volatility risk, and climate risk on Greek corporate green bond returns and pricing. While existing literature often examines these risks in isolation or within traditional bond markets, our research focuses specifically on green bonds, an underexplored asset class. We first analyze the effect of idiosyncratic volatility on green bond returns. More importantly, we develop a novel five‐factor pricing model for green corporate bonds, integrating a volatility factor, a climate risk factor, and a bond market factor into a standard bond pricing framework. To account for varying macroeconomic conditions, particularly the pronounced inflationary cycles in Greece, we apply Markov Switching Regression. Our findings reveal that the impact of idiosyncratic volatility on Greek green bond returns is contingent on inflationary pressures. Furthermore, our five‐factor model demonstrates that under inflationary regimes, increased climate risk negatively affects green corporate bond valuations, while volatility risk becomes insignificant. Conversely, during non‐inflationary periods, investors respond positively to increasing climate risk and decreasing volatility risk. The proposed model effectively captures volatility and climate risk premia, offering a significant contribution to explaining the excess returns of green corporate bonds.