Air pollution and stock returns in the US

Health related research documents that air pollution has negative mood effects. Experimental works in psychology relate bad mood to increased risk aversion. Studies in financial economics report an observed link between mood effects and stock market returns. This study therefore investigates whether the mood effects caused by air pollution can have economic implications. It examines the relationship between air pollution and stock returns using data from the Air Quality Index, and stock returns from four stock exchanges in the US. We find that air pollution is negatively related to stock returns, even when controlling for other variables. The relationship becomes weaker as the distance of the stock exchange from the polluted area increases. The results also indicate that air pollution may even affect local traders investing in securities exchanges located far from the polluted area. The findings imply that a profitable trading strategy can be constructed. (C) 2011 Elsevier B.V. All rights reserved.