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Summary Sustainable Finance
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A full summary of all the important subjects of the UU course 'Sustainable Finance', including all lecture slides and important papers.
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Sustainable financeLecture 1: Introduction
Financial materiality = identifying material ESG risk in financial models, lending
decisions, portfolio risk analysis, portfolio management. Critiques are the lack of solid
evidence, no proper data, and uncertainty.
Impact materiality = impact investing (private equity, green/impact bonds). There
now also is a trend toward impact labelled investments in secondary market.
Critiques are green/impact washing, there are no solid targets.
DCF formula: Valuei,t=0 = (FCFt+1)/(1+WACCi) + (FCFt+2)/((1+WACCi)2) + … + (FCFt+5)/((1+WACCi)5)
+ TV5 / ((1+WACCi)5)
Valuei,t=0 Value of operating assets today (t=0)
FCFt+1 Expected Free Cash Flow paid by firm I in year t+1
WACCi weighted average cost of capital of firm I applied to cash flows in all years
gst constant growth rate in free cash flow after year T+5 (where gst < WACC)
TV5 terminal (continuing) value of constantly growing FCFs after year 5 (i.e.,
assumed growth at constant rate forever)
Bernstein, A., Gustafson, M. T., & Lewis, R. (2019). Disaster on the horizon: The price effect
of sea level rise. Journal of financial economics, 134(2), 253-272.
This paper delves into the complex situation of the combination of sea level rise and its
consequential impact on real estate markets. Using an analysis by a dataset of the US, the
researchers aim to elucidate the economic ramifications of this environmental challenge.
One of the key findings is about the correlation between variations in sea levels and
fluctuations in property values, in which we see that rising sea levels move together with
depreciation in the market worth, depending on their location and some other
characteristics. Of course, properties in highly exposed areas experience higher decrease in
value.
This leads to homeowners facing challenges in obtaining insurance due to concerns about
property value depreciation and risks of rising sea levels. Local governments in vulnerable
areas have implemented adaptation measures such as raising the building elevation
requirements, installing seawalls, and other precautionary measures, to minimize the
economic costs of future flooding events.
The research serves as a wake-up call regarding the urgency of addressing climate change
and its implications for economy and society, by quantifying the economic costs associated
with sea level rise.
Bolton, P., & Kacperczyk, M. (2023). Global pricing of carbon ‐transition risk. The Journal of
Finance, 78(6), 3677-3754.
This paper delves into global carbon-transition risk pricing. This is, due to the increasing
urgency of addressing climate change, a crucial consideration in economics and finance
nowadays. The authors research the combination of carbon emissions, economic activities,
and financial markets, by analyzing implications and challenges associated with carbon-
transition risk.
There is a need for a systematic approach to pricing carbon-transition risk, given its huge
consequences, while traditional financial models often fail to adequately price risks of events
due to climate change, and the costs of transition to a low-carbon economy.
,Empirical and theoretical evidence describe impact on asset pricing (a carbon tax in a
particular country can lead to a decline in the market value of coal-fired power plants),
corporate performance, and macroeconomic stability. The authors also emphasize upon the
interconnectedness of ESG (environmental, social and governance) factors with financial
markets, showing how climate change can affect many different sectors and geographies.
The paper also sheds light on the role of policy interventions, technological advancements,
and market dynamics, by testing the effectiveness of those.
The authors also highlight the broader implications for society, describing the need for
coordinated action at the global level to accelerate the transition, encouraging collaboration
between different groups.
Huisman, R., Koolen, D., & Stet, C. (2021). Pricing forward contracts in power markets with
variable renewable energy sources. Renewable Energy, 180, 1260-1265.
This paper delves into the dynamics of pricing forward contracts in power markets, especially
in the case of VRES (variable renewable energy sources), like wind and solar.
The paper describes the importance of forward contracts in mitigating market risks for both
producers and consumers of electricity, as forward contracts allow parties to lock in prices
for future electricity delivery, providing stability. But VRES also introduces new challenges
because of the variability and dynamics. Therefore, the authors propose a new pricing
model, using math (especially time series analysis). The model includes factors such as the
correlation between VRES and electricity demand, the availability of backup capacity to
compensate for fluctuations, and market-specific factors such as policies, transmission
constraints, and technologies.
The paper uses simulations to demonstrate the effectiveness of their pricing model in
accurately valuing forward contracts in power markets with VRES.
The paper contributes to the literature by offering a sophisticated pricing framework tackling
complexities caused by VRES. Their model can assist market participants in making better-
informed decisions and managing risks effectively.
, Lecture 2: Research perspectives on green bonds
Green bonds: any type of bond instrument where the proceeds or an equivalent amount will
be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible
Green Projects and which are aligned with the four components of the GBP.
Green bonds are issued by firms, banks, and the government. It is important to regulate the
bonds, as otherwise companies can be doing greenwashing. Current regulation are some
standards (CBI CBS Climate Bonds Standard, ICMA GBP Green Bond Principles, EuGBS
EU Green Bond Standard).
It can be difficult to see a relationship between Green bonds and CO2 emissions, as it may be
difficult to identify which projects are financed by the Green bonds.
Buying Green bonds may be sufficient to investors, as it increases utility due to
environmental preferences for some individuals, it hedges climate risks and may lead to
better returns.
Flammer, C. (2021). Corporate green bonds. Journal of Financial Economics, 142(2), 499-516
This paper delves into the growing trend of green bonds issued by corporations.
The paper indicates reasons for corporations to issue green bonds, including showing
environmental responsibility, gain green long-term investors, and potentially reduce the cost
of capital.
The author examines whether issuing green bonds has impact on environmental
performance. Some studies suggest a positive effect, while others find no significant
difference.
The paper also explores the impact of issuing green bonds on financial performance.
Evidence suggests that green bond issuers may experience a temporary increase in stock
prices around the time of issuing, while the long-term financial performance remains
uncertain. The author states that future research is needed to fully understand financial
implications.
The paper also addresses the issue of greenwashing, where firms issue green bonds without
committing to environmentally sustainable practices, raising questions about the credibility
and effectiveness of green bonds in driving real environmental change.
The paper finally discusses potential policy interventions to increase the effects of green
bonds in promoting sustainability and affect the environmental change. It for example
includes standardizing reporting requirements, increasing transparency, and strengthening
regulatory oversight to prevent greenwashing.
Zerbib, O. D. (2019). The effect of pro-environmental preferences on bond prices: Evidence
from green bonds. Journal of Banking & Finance, 98, 39-60
This paper investigates whether pro-environmental investors are willing to accept lower
yields for green bonds compared to conventional bonds, thereby affecting bond prices. The
author uses a dataset and compares Green Bonds with comparable non-green bonds.
One of the key findings is that the issuance of Green Bonds is associated with a decrease in
bond yields, indicating that investors are willing to accept lower returns for environmentally
friendly investments. This decrease is called the Greenium. The study also finds evidence that
the impact varies across different market segments and over time. The effect is larger in
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