Particles, Pollutions and Prices

We investigate whether a sentiment effect arising from poor air quality negatively affects stock prices. We find little evidence suggesting that local air quality directly affects stock prices. However, we show that the local air quality index (which is increasing in air pollution) relative to that of Beijing negatively affects stock prices. We apply a discontinuity design that focuses on observations with the relative air quality index falling in the narrow band around zero and find a consistent result. Additional analysis unveils a subsequent reversal in stock prices in response to the relative air quality. Further, the relative air quality index also negatively affects trading volume. Finally, we show that the negative association between stock prices and the relative air quality index is not influenced by economic fundamentals or investor sophistication. In sum, our findings suggest that poor air quality negatively affects stock prices and investor trading activities.