2023 Australasian Actuarial Education and Research Symposium

Yuhao Liu

UNSW

Utility indifference pricing of green bonds

The green bond market was born in 2007, started to accelerate from 2014, and has reached US$2.334 trillion globally as of June 2023. Green bonds, as an innovative financial instrument, have played an important role in capital mobilization towards climate change mitigation and adaptation. This study aims at the pricing of a single-period defaultable green bond. Main challenges of the pricing task include the following: First, the prices of financial assets are significantly influenced by the financial risks induced by climate change; Second, and more importantly, investors may derive non-pecuniary benefits from green asset investments, as revealed by empirical research on Environment, Social and Governance (ESG) investing. We develop a utility indifference pricing framework that encapsulates both the climate-related financial risks and the non-pecuniary benefits from green investments. This framework provides a probabilistic representation of the utility indifference price of the bond. Moreover, we conduct extensive numerical analyses to examine the effects of the climate risk and non-pecuniary benefits on the price.