Preferred habitat investors in the green bond market.

In recent years, the green bond market has seen significant growth as a means of financing environmentally-friendly projects. While much research has focused on pricing, limited attention has been given to green bond investors. This paper analyzes the preferences of different investor groups for green bonds and introduces the term "green bond preferred habitat". Conceptually, green bond preferred habitat investors hold green bonds disproportionally and display lower price elasticity than other investors. This study combines information from 2693 unique green bonds with confidential bond-level portfolio holdings data from the ECB over the period 2016-Q4 to 2022-Q4, covering more than 12 million observations. The results demonstrate that European investors, particularly mutual funds and pension funds, show a high demand for green bonds. In contrast, insurance corporations tend to avoid green bonds. Our findings show that the demand for green bonds among mutual funds and pension funds is price inelastic, while banks and insurance corporations display an elastic demand. These findings are robust for potential endogeneity concerns when we apply matching techniques, are stronger for domestic green bonds, and also apply to sustainability-linked bonds. These results on the divergence in investor demand are important for green bond issuers because firms and governments issue green bonds to cater certain investors willing to sacrifice returns. One theoretical implication is that if green bond preferred habitat is sufficiently strong, it creates a price wedge due to their high demand for green bonds which explains the existence of a greenium. • Green bond markets have grown significantly in recent years, expanding to over two trillion euros in market size by the end of 2022. While the market has expanded, relatively little is known about who holds green bonds. • Using granular bond-level data from the ECB securities holdings statistics (SHS-S) we aim to fill this gap by showing that European investors invest 3.7% of their bond portfolio in green bonds, while green bonds represent only 1.5% of the total bonds outstanding value. • In particular, we show that mutual funds and pension funds invest disproportionally in green bonds and that their holdings are very price insensitive, which fits into our proposed theoretical framework of "green bond preferred habitat". By contrast and surprisingly, European insurance corporations shun green bonds. [ABSTRACT FROM AUTHOR]