Interest Rates and their Differential Effect on the Pricing of Green and Conventional Bonds : An empirical analysis of the Nordic and US bond market from 2017-2023

Abstract

Financial markets play a significant role in the transition towards a net-zero economy. Recent events, specifically the pandemic and Ukraine conflict, have been drivers for increased volatility in financial instruments, mainly due to rapid and frequent changes in interest rates. This study investigates how these interest rate fluctuations impact the differential pricing of green and conventional bonds, and if there exist any regional disparities. By comparing the Nordic and the US bond markets, we find that in the Nordic market, green bonds display greater volatility mainly due to their longer duration. Assuming a successful matching process where each green bond is paired with its closest conventional counterpart, this implies that green bonds posit higher risk in an increasing interest rate environment, which may impact the financial performance of investors. The US market exhibits significantly greater overall volatility due to the higher duration of American bonds; however, no significant differential effect on green bond prices is identified. This indicates that the American bond market is more exposed to interest rate hikes, resulting in a less predictable investing territory. We further document that differences exist between the two regions regarding size, regulations, and investor preferences, which explains why we see differences in bond performance between these regions.