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The Next Step in Green Bond Financing

Green bonds allow issuers to capture a clientele-induced yield discount, but fragment bond issues, which is bad for liquidity and comes at the expense of expected returns. We propose to unbundle (strip) a green bond into a regular bond and a green certificate that takes care of green earmarking of bond revenues. We show theoretically that in the context of a bond market with search frictions, this setup leads to higher liquidity for the bonds used to financed green projects (direct and visible effect), but also to a spillover effect on all other bonds (indirect and invisible effect). Together, these lead to a much lower effective cost of debt for green projects. As a result, green projects are more likely to be undertaken.