The economics of green debt

We investigate the economics of green debt by modeling markets for green and regular bonds. Issuers use green bonds to cater to climate investors, thereby reducing funding costs but potentially also rationing volumes. Moreover, green bonds fragment debt issuances, which impairs liquidity and increases funding costs. Consequently, the possibility to issue green bonds can in- or decrease the volume of and the cost at which green and/or brown projects financed. Similarly, pressure on investors to become more sustainable may work or may backfire. We propose an alternative security design that preserves green earmarking but prevents fragmentation and rationing.