The Influences Of Air Pollution On Chinese Stock Market

Air pollution in China is becoming more and more serious,and has threatened people’s life safety and mental health.Individual investors,who are susceptible to mood,persistently dominate the trading in Chinese stock market.Therefore,compared with the developed stock market,the Chinese stock market is affected by more irrational factors.This provides an ideal setting for the study of the impact of air pollution on Chinese stock market from the perspective of investor sentiment.A large number of medical and psychological literature have shown that air pollution would lead to pessimism and risk aversion in both the long and short term.Based on the assumption that air pollution causes pessimism among investors,and thus affects their investment decisions in the stock market,this paper constructs air pollution induced local,individual and institutional investor mood indices,respectively.The influence mechanism of air pollution on stock pricing and trading behavior is studied systematically and deeply.First,this paper studies the impact of air pollution induced local investor mood on the Chinese stock market.The results show that air pollution affects local investor mood,and local investors are prone to home bias,thus furthermore affecting the stock pricing of locally headquartered firms.Severe air pollution reduces the stock returns,liquidity and volatility of locally headquartered firms,which is not driven by the mechanisms that air pollution affects local economic activities,but through the channels of investor smood.The impact of air pollution on local stock returns is more pronounced for firms are difficult to value and arbitrage.Second,this paper invesgates the impact of air pollution induced individual investor mood on the Chinese stock market.The results are as follows.This paper constructs a individual investor sentiment index,which is only significantly related with the trading activities of individual investors.The more pessimistic the individual investor mood,the lower the stock returns,liquidity and volatility.The abnormal returns of individual investor mood portfolios cannot be eliminated by recent asset pricing models,confirming the limited efficiency in Chinese stock market.Third,this paper examines the impact of air pollution on the Chinese stock market.The results show that the pessimistic fund manager mood significantly reduces the liquidity and volatility.The more pessimistic the fund manager mood,the lower the stock returns,and the effects are remarkable for firms with high arbitrage costs.Relative to previous literature,the innovations of this paper are as follows.First,this paper examines the impact of air pollution on local stock pricing and trading activities from the perspective of home bias.This paper reveals the local preference mechanism of air pollution affecting stock pricing in Chinese stock market.It not only confirms the existence of local preference in Chinese stock market,but also adds the evidence for negative correlation between air pollution and stock returns.Second,this paper constructs a firm-level index that directly measures individual investor mood caused by the natural conditions.This study reveals that air pollution would negatively influence stock pricing through individual investor mood channel.Moreover,this paper proves that the limited market efficiency in Chinese stock market is limited due to various arbitrage constraints.Third,this paper studies how air pollution affects stock pricing through its fund manager mood channel.The results in this paper proves that institutional investors are not completely rational,but also affected by mood,therby leading to their behavior bias in stock market.This study also confirms that the asset mispricing caused by investor mood is more significant for stocks with higher arbitrage cost.