Green parachutes: the green bond asymmetric liquidity hypothesis

Abstract The often-observed ‘greenium’ poses a philosophical challenge for the proverbial homo economicus, who may deem it irrational and a failure of fiduciary responsibility, prima facie, to invest in green bonds with an inherently inferior to-maturity economic return versus a same-issuer conventional comparator. In pursuit of partially justifying the greenium, we assess the credit spread behaviour of EUR-denominated green bonds in search of additionality in portfolio construction. Our hypothesis posits that the stylised heterogeneous behaviour of green bond investors, per Flammer (2021), may contribute beneficially to volatility-attenuation during periods of underlying market stress. Our findings confirm this, highlighting the utility of green bonds in creating positive downside portfolio convexity versus comparators. We conjecture that an investment manager could, ex ante, determine the viability of “volatility laundering” through green bond substitution by invoking the Berk and Green (2004) model, given a view on the future path of conventional comparator spreads.