Air Pollution, Behavioral Bias, and the Disposition Effect in China

Inspired by the recent health-science findings that air pollution reduces human cognitive skills, we examine whether air pollution can intensify cognitive bias observed in the financial markets. Based on a proprietary dataset obtained from a large mutual fund family in China, which contains the complete trading information of over 773,198 accounts covering more than 200 cities, we find that air pollution significantly increases the disposition effect of investors. Analysis based on two plausible exogenous variations in air quality (the Huai-river policy and the vast dissipation of air pollution due to strong winds) supports a causal interpretation. Our results have important normative implications that air pollutions may incur severe indirect (social) costs associated with enhanced cognitive biases.