Pollution and Performance: Do Investors Make Worse Trades on Hazy Days? Jiekun Huangy Nianhang Xuz Honghai Yux This Draft: May 2019 Forthcoming in Management Science We thank Tyler Shumway (the Editor), an anonymous associate editor, two anonymous referees, Heitor Almeida, Samuel Hartzmark, David Hirshleifer, Juhani Linnainmaa, Bo Liu, Dong Lou, Xiaomeng Lu, Nolan Miller, Neil Pearson, Kim Peijnenburg, Veronika Pool, Julian Reif, Clemens Sialm, Avanidhar Subrahmanyam, Yongxiang Wang, Scott Weisbenner, Hongjun Yan, Sterling Yan, Chengxi Yin, Hao Zhang, and seminar participants at the 2017 China Financial Research Conference, the 2018 European Finance Association (EFA) meetings, the 2016 China Young Finance Scholars Society conference, Renmin University of China, Dongbei University of Finance & Economics, and Central South University for helpful comments and discussion. Qinyuan Chen, Rui Dong, Zhe Li, Rowan Salem, Zhongnan Xiang, and Yan Xu provided excellent research assistance. Xu acknowledges the …nancial support from the National Natural Science Foundation of China (Grant Nos. 71622010 and 71790601). Yu acknowledges the …nancial support from the National Natural Science Foundation of China (Grant Nos. 71720107001 and 71672081). We retain responsibility for any remaining errors. y Department of Finance, Gies College of Business, University of Illinois at Urbana-Champaign; e-mail: huangjk@illinois.edu. z School of Business, Renmin University of China; e-mail: nhxu@ruc.edu.cn. x School of Management and Engineering, Nanjing University; e-mail: hhyu@nju.edu.cn. Electronic copy available at: https://ssrn.com/abstract=2846165 Pollution and Performance: Do Investors Make Worse Trades on Hazy Days? Abstract This paper examines the relation between air pollution and individual investors’ trading behavior and performance. Using unique data on stock trades by 87; 054 individuals from 34 cities in China, we …nd a negative relation between air pollution and trade performance. This result is obtained after controlling for investor-year …xed e¤ects, date …xed e¤ects, as well as local weather conditions. More strikingly, abnormal trade performance decreases monotonically with the levels indicating the severity of air pollution. Furthermore, we …nd evidence suggesting that air pollution makes investors more susceptible to the disposition e¤ect and attention-driven buying behavior. Overall, the results highlight a hitherto unexplored cost that ambient air pollution imposes on stock market investors. JEL Classification: G11, G23, G14 Keywords: Individual investors, air pollution, trade performance, behavioral bias Electronic copy available at: https://ssrn.com/abstract=2846165 1 Introduction Ambient air pollution is a major environmental health problem faced by countries worldwide. For example, European Environment Agency (2015) lists air pollution as the “single largest environmental health risk” in Europe. According to the State of the Air 2016 report by the American Lung Association, more than half of the people in the U.S. live in counties that have unhealthful levels of either ozone or particle pollution. Recent medical studies have shown that ambient air pollution impairs cognitive functioning (see, e.g., Pope and Dockery, 2006; Block and CalderónGarcidueñas, 2009). Such adverse cognitive e¤ects suggest that air pollution can negatively impact activities and decisions that require mental e¤ort. While stock trading decisions are commonly viewed as cognitively demanding and can have large …nancial impacts on households, the in‡uence of air pollution on investor outcomes remains underexplored. In this paper, we provide one of the …rst studies of the relation between air quality and individual investors’stock trading behavior and performance. Stock trading decisions are complicated and often require signi…cant cognitive e¤ort. To avoid making money-losing trades, individual investors have to evaluate complex fundamental factors that can in‡uence trade performance, such as information about the fundamentals of the …rm, the riskreturn tradeo¤, transaction costs, and so on. Decreased cognitive functioning due to air pollution may lead investors to rely on heuristics in the decision-making process and exhibit behavioral biases.1 Therefore, we hypothesize that air pollution negatively a¤ects trading performance. We use unique account-level equity transaction data from a large Chinese brokerage house to examine the in‡uence