Green Returns

In the NBER working paper “Dissecting Green Returns,” Lubos Pastor, Robert Stambaugh, and Lucian Taylor argue that excess returns on green assets during recent years are unlikely to predict expected excess returns. At least that’s what theory suggests:

… green assets have lower expected returns than brown, due to investors’ tastes for green assets, yet green assets can have higher realized returns while agents’ tastes shift unexpectedly in the green direction. … green tastes can shift in two ways. First, investors’ preference for green assets can increase, directly driving up green asset prices. Second, consumers’ demands for green products can strengthen—for example, due to environmental regulations—driving up green firms’ profits and thus their stock prices.

In the data

… green stocks significantly outperformed brown stocks in recent years. … green stocks would not have outperformed brown without strengthened climate concerns. …

The bulk of the positive relation between green stock returns and climate-concern shocks evidently occurs with multi-week lags.

Expected returns on stocks are hard to identify, in contrast with expected bond returns. That’s why the authors analyze bond prices and yields:

The inverse relation between a bond’s realized return and the change in its yield to maturity is well understood, and the yield provides direct information about expected return, especially for buy-and-hold investors.

The case of German “twin” bonds illustrates this inverse relation in the context of climate concerns. Since 2020, the German government has issued green bonds, along with virtually identical non-green twins. The green bonds trade at lower yields, indicating lower expected returns compared to non-green bonds. The yield spread between the green and non-green twins, known as the “greenium,” reflects investors’ willingness to accept a lower return in exchange for holding assets more aligned with their environmental values. Since issuance, the 10-year greenium experienced roughly a three-fold widening, presumably due to growing climate concerns. As a result, the green bond outperformed its non-green twin by a significant margin over the same period. However, this outperformance does not imply green outperformance going forward. Rather the opposite is clearly true, given the now wider greenium.