Why investors may want to keep tabs on air pollution

Americans are increasingly aware of the negative health impact of air pollution, but researchers have found another reason to track air quality: its impact on stock market returns.

When pollution levels rise in Manhattan, stocks take a dive, according to a new study from researchers at the University of Ottawa and Columbia University. The study tracked the S&P 500 index, the most widely cited New York Stock Exchange benchmark, over a 15-year period and compared its returns with hourly measures of fine particulate matter in lower Manhattan, where the NYSE is based.

The one standard deviation increase in air pollution decreases returns by 11.9 percent, or what the researchers deemed a “substantial effect on daily NYSE returns.”

In other words, a bad air day could crash the market.

While it may be difficult for most investors tailor their trades based on New York City’s pollution levels, the findings cast a new light on a popular theory called the “efficient market hypothesis,” which posits that asset prices bake in all relevant information. But what if outside forces -- like pollution -- can move the market in ways that aren’t logical or easy to pick out?

Increasingly, economists are digging up evidence that outside factors, including traders’ emotions, can influence stock prices. When it comes to air pollution, the particulates could be quite literally messing with investors’ heads, the researchers theorize.

“We hypothesize that pollution decreases the risk attitudes of investors via short-term changes in brain and/or physical health,” they wrote in the paper, which was published this week at the National Bureau of Economic Research.

The research follows on previous findings that New York’s air quality might affect traders. A 2011 paper published by the Journal of Economic Psychology found a link between the Air Quality Index and stock returns on four U.S. exchanges. Yet up until recently, most economic research has focused on how air pollution affects worker productivity, rather than the market.

Higher air pollution levels harm outdoor laborers, but it can also hurt office workers. One study at a Chinese call-center found that workers handled more calls when the air quality improved. While workers inhale pollution as they commute into their offices and then feel worse when they sit at their desks, fine particulates can easily enter office buildings, the researchers on the stock market paper noted.

“Unlike other common air pollutants -- which either remain outside or break down very rapidly once indoors -- going inside reduces one’s exposure to [fine particulate matter] only minimally,” according to the paper.

So it might be time for investors to keep tabs on the Air Quality Index in addition to the other usual stock market indicators.