Reduced interest option pricing for green bonds

Abstract

Purpose

This paper originally proposed the fuzzy option pricing method for green bonds. Based on the requirements of arbitrage equilibrium, this paper draws on Merton's corporate bond option pricing model.

Design/methodology/approach

Describing the asset value behavior of green bond issuing enterprises through diffusion-jump processes to reflect the uncertainty brought by carbon emission reduction policies and technologies, using approximation methods to get the analytical pricing formula and then, using a fuzzification technique of Choquet expectation under  λ-additive fuzzy measures after considering fuzzy factors, the paper provides fuzzy intervals for the parity coupon rates of green bonds with different subjective levels for investors.

Findings

The paper proposes and argues the classical and fuzzy option pricing methods in turn for both corporate ordinary bonds and green bonds, considering carbon risk or climate risk. It implements the scenario analysis varying with industry emission standards and discusses the sensitiveness of the related key parameters of the option.

Practical implications

The fuzzy option pricing for the green bonds provides the scope of the variable equilibrium values, operational theoretical supports and some policy implications of carbon reduction and promoting green funding.

Originality/value

The logic of introducing the fuzziness of the option pricing for the green bonds lies with considering the existence of fuzzy information about the project supported by the green bond and the subjectivity of investors and it also responds to changes in technological uncertainty and policy uncertainty in the process of “carbon peaking and carbon neutrality.”

Citation

Zheng, C., Jin, J. and Han, L. (2024), "Reduced interest option pricing for green bonds", China Finance Review International, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/CFRI-07-2023-0178