Green bond vs. Islamic bond: Which one is more environmentally friendly?

Area of Science:

• Finance
• Environmental Economics
• Sustainable Finance

Background:

• The S&P Kensho Clean Energy (CE) and Cleantech (CT) indices represent key sectors for environmental investment.
• Green bonds and Islamic finance (Sukuk) are growing alternative investment instruments.
• Understanding the dynamic relationships between these sectors is crucial for sustainable investment strategies.

Purpose of the Study:

• To investigate the dynamic dependence and causality between clean energy/cleantech indices and green/Islamic bond indices.
• To identify which specific bond indices exhibit the strongest relationships with clean energy and cleantech.
• To provide insights for policymakers and investors in sustainable finance.

Main Methods:

• Quantile cross-spectral analysis (coherency) to assess dynamic dependence.
• Frequency domain analysis to determine the direction of causality.
• Examination of S&P Kensho Clean Energy (CE) and Cleantech (CT) indices.
• Analysis of S&P Green Bond (GB) and Green Bond Select (GBS) indices.
• Evaluation of A-, AA-, AAA-, and BBB-graded Sukuk Indices.

Main Results:

• Dependence of CE and CT on Sukuk and green bond indices strengthens in the long- and medium-term, particularly during normal or bearish market conditions.
• AA- and A-rated Sukuk indices, along with the GBS index, show higher coherency with CE and CT compared to other instruments.
• Causality predominantly flows from Sukuk and bond indices to CT and CE across most frequencies, with AA-rated, A-rated, and GBS indices demonstrating more significant effects.

Conclusions:

• Islamic and green bonds are significant drivers for clean energy and cleantech sectors, especially during market stress.
• AA- and A-rated Sukuk and GBS indices offer strong linkages for clean energy investments.
• Findings support policymakers in promoting green projects and guide investors in portfolio diversification and hedging within sustainable finance.