The new bond on the block — Designing a carbon-linked bond for sustainable investment projects

Niklas Dahlen, Rieke Fehrenkötter and Maximilian Schreiter

The Quarterly Review of Economics and Finance, 2024, vol. 95, issue C, 316-325

Abstract: Over the last decade, the green bond market experienced strong growth rates fueled by the need to combat climate change. However, the discourse on enhancing the effectiveness of green bonds primarily revolves around regulatory measures, often overlooking the possibility of designing inherent incentives. We show that a green bond with a coupon structure positively related to the carbon price development stimulates (early) investment in an emission-reducing project and creates higher net present values (NPVs) when applied in project financing. In our simulation-based framework, we model carbon prices using a geometric Brownian motion, and create a general optimal stopping time problem regarding the start of the project. The green bond in our setting carries the risk of default, also mitigated by its carbon price-linked coupon structure.

Keywords: Carbon price; Optimal stopping; Emission-reducing projects; Optimal corporate investment; Index-linked bond; Carbon finance (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:quaeco:v:95:y:2024:i:c:p:316-325

DOI: 10.1016/j.qref.2024.04.010

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