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Alternative Green Bond Designs
The effects of climate change are becoming more apparent and with that the need to act. Meeting the announced pledge to limit the effects of climate change requires large financial resources, for which there is still a financing gap. Hence, finding efficient financing instruments is an important element to combat climate change. In this paper, we compare different green bond designs including fixed-rate, carbon-linked, inflation-linked, and convertible (green) bonds. We assume that the proceeds are invested into an emission-reducing project thus generating returns in form of saved CO2 certificates. The carbon price is assumed to follow a geometric Brownian motion simulating a general optimal stopping time problem for the start of the investment project. Our simulation results indicate that most alternative bond designs do not set superior incentives compared to traditional green fixed-rate bonds. The only design that outperforms fixed-rate bonds, are green carbon-linked bonds following a coupon design inversely linked to the development of carbon prices. This is surprising given the latest issuance of green inflation-linked and green convertible bonds. Thus, the findings question whether alternative and more complex green bond designs are the right tool to combat climate change.