Green Bond Effects on the CDS Market 

By | March 8, 2023

Since 2007, a novel debt type, green bonds, has emerged as a popular instrument to raise and direct capital toward projects that curb climate change risk. Corporations, government agencies, supranational entities, and municipalities issue these bonds mainly in the US, China, and Europe. Annual green bond issuance has experienced exponential growth from $37.1 in 2014 to $558.6 billion in 2021. The green bond boom echoes sustainability preferences among investors. According to a study by Hartzmark and Sussman, following the publication of the first sustainability ratings in March 2016, mutual funds with the highest sustainability ratings received $24 billion greater fund flows, while those with the lowest ratings experienced a $12 billion reduction in fund flows. As of 2021, corporations represent 53.5% of total issuance. They must invest cash proceeds from green bond issuance in environmentally friendly projects.  

Flammer (2021) asks why firms issue green bonds instead of conventional ones, knowing that “the proceeds from green bonds are committed to green projects, which restricts companies’ investment policies.” Various researchers address the question by analyzing the effect of green bonds on the cost of debt and stock returns. On the one hand, Flammer (2021) and Daubanes et al.(2021) find that stock returns positively react to green bond issuances, suggesting that equity holders reap the benefits from transitioning towards eco-friendly projects. On the other hand, the impact of green bonds on the cost of borrowing is not crystal-clear when the bond market is analyzed. For instance, Larcker & Watts (2020) and Zerbib (2019) find that firms issuing green bonds bear a similar cost of debt as conventional bonds; companies do not benefit from a cost premium, referred to as a “greenium.” However, Caramichael et al. (2022) show that since 2019, green bonds have provided a cost advantage compared to conventional bonds.  

Our research sheds light on the impact of green bond issuance on default risk, a topic that has not received much attention. A relevant way to measure default risk is to look at the changes in credit default swap (CDS) premiums. CDS is a financial instrument held by investors, usually the firm’s creditors, to insure against losses from the firm’s missing debt payments. The CDS premium, or spread, is the price of this insurance. Hence, a change in the CDS premium directly reflects the firm’s default likelihood perceived by investors.  

We conduct our analysis for US, European, and Japanese non-financial firms because these regions are most active in issuing green bonds, and their CDS markets are the most liquid. We focus on firms that had issued at least one green bond between 2013, the year of the first issuance of corporate green bonds, and 2021. We compare the reaction in the CDS premium when a company announces the issuance of a green bond versus the issuance of a conventional bond.   

 We obtain three effects: the green effect, the credibility effect, and the spillover effect. First, the CDS market reacts differently based on the green or conventional bond type. While the CDS spread increases when a conventional bond is issued, it decreases when a green bond is issued. The virtuous effect of issuing green bonds for a firm is due to the additional information on the green investment project and the reduction of overall risk for firms that embrace the transition to sustainability. This green effect is particularly pronounced when firms issue their first green bonds; by issuing green bonds, firms signal to be in the awareness stage of engaging in the green transition by pursuing green-compatible investment strategies. Thus, firms that shift assets from brown to green reap value from an increase in revenues, as they can meet customers’ demand for green products and from a reduction in environmental risk.  

Second, when investigating the case of multiple green bond issuances, we find that the CDS spread barely reacts following the second green bond issue. However, it reverts to be substantially negative in the case of the third and beyond bond issues. While the first green issue leads to a green discount, the second adds little to how firms signal their commitment to green transition. Thus, the firm’s credibility is strongly enhanced with three or more green bond issuances, leading to the appearance of an additional green discount. Thus, multiple issuance signals firms to be in the deployment stage, and, therefore, they can mitigate greenwashing concerns. When a firm commits to transitioning its business to an environment-friendly one, it frequently issues green bonds as part of its financing schemes. Thus, it promotes its environmental legitimacy and enhances its credibility among investors. 

Finally, we show that a decrease in the CDS spread, observed in the case of green bond issuance, also exists for conventional bonds that are issued after the third green issuance. Thus, the credibility effect leads to a spillover effect, where the CDS spread becomes negative and significant when conventional bonds are also issued. Recurrent issuance of green bonds increases the information available to investors, reducing information asymmetry between firms and investors. Thus such information will be considered when conventional bonds are issued. Investors’ positive perception of the firm’s risk should thus materialize even in conventional bond issuances. 

Our findings provide important implications for firms and policymakers. First, they show that green bonds can help reduce the perceived default risk of firms and can be used as a tool to improve access to capital markets and reduce the costs of financing. Second, they suggest that green bonds can encourage firms to undertake projects with positive environmental impacts. Finally, our results suggest that the role of green bonds is essential as a sustainable financing instrument in the green transition.  


Jung-Hyun Ahn is an Associate Professor in Finance at NEOMA Business School.  

Sami Attaoui is a Professor of Finance, the Head of the Finance Department, and the Global Executive MBA Academic Director at NEOMA Business School. 

Julien Fouquau is a Professor of Finance at ESCP Business School. 


This post is adapted from their “Green Bond Effects on the CDS Market” paper, which is available on SSRN.  

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