High levels of "fine particulate matter" (PM2.5) in the air — such as in haze or smog — can lower the stock market, a research team at Columbia University has found.
When particle pollution rises, the market goes down by small but measurable amounts, says team leader Matthew Neidell, an associate professor at Columbia University.
To find out about a possible correlation here, Neidell and his colleagues placed an air pollution monitor close to the New York Stock Exchange and took hourly measurements of air pollution. They were able to compare the times when air pollution reached certain levels with the returns on the Standard & Poor's 500 index for that same day.
“We found when the entire day had a higher level of particulate matter, we saw the S&P 500 dropped,” Neidell says. “In particular, we found that when particulate matter levels were higher in the morning and throughout the early afternoon, [that] had the biggest impact on the S&P 500.”
Fine particulate matter are less than 2.5 microns in diameter, so they can't be seen with the human eye. They come from natural sources, such as forest fires and volcanoes, but in cities, most of it comes from the combustion of fossil fuels. “Given how small they are, they're able to penetrate deep within our body,” Neidell explains. “They pass through our lung barrier and into our blood, which can have effects.”
What surprised the researchers the most was the fact that they “found any relationship at all” between pollution and the behavior of traders on the exchange, Neidell says. “We had a small inkling that there might be a relationship between these two [things], but we were going a bit on a whim … We were surprised to find as robust of an effect as we did. What's interesting about this is that in New York City, the air quality is actually surprisingly good. So, if we're doing a study in Beijing or London, where air quality is generally worse, we might see much bigger changes.”
Neidell says his study builds on previous research that has found various effects of air pollution on human well-being, beyond health. Results from previous studies have indicated that air pollution might influence mood and cognitive performance. More pertinent to this study, however, was evidence showing that when someone's mood drops or their mental abilities falter, they tend to become more risk averse in the decisions they make, Neidell says. Traders may, for example, move away from stocks and shift toward bonds, which are typically safer bets. When this happens, the price of the S&P 500 drops.
Neidell and his team looked at something called the "volatility index," which "a lot of people use as a measure of trader fear,” Neidell says. “What we find is that on days with higher fine particulates, we also see a decrease in that index … We think that's suggestive of risk aversion being what's driving the results.”
Neidell notes that the study doesn’t necessarily prove anything. The effect, while statistically significant, isn’t very big, he says. A very large change in particulate matter leads only to a “moderate-to-small-size effect on returns.” If particulate matter rises from the bottom 25th percentile, the best quartile, to the 75th percentile, the worst quartile, returns would decrease by two basis points, Neidell says. “This is a .02 percent decrease, so it's not the most enormous effect, but we do see it.”
Two cents on the dollar may not sound like a big deal, but traders make a lot of money by consistently squeezing a 10th of a penny out of many, many transactions.
Neidell sees two important features of his results: “The first is that there's a strongly held belief that stock markets work efficiently — something called the 'efficient market hypothesis' — that the price of a stock solely reflects the expected future profitability of a firm,” he says. “But our research shows and other research has shown before, that there's more to it than just that. There's a role for moods and emotions and things like that affecting a stock price.”
“The other thing that we think is interesting from a policy perspective is that pollution is affecting the performance of workers in a high-skilled occupation, in a very knowledge-based setting. We think that has important implications for the effects on the economy on a broader level,” he says.