Color determines threat level. Threat level determines the amount of xp you get (e.g. - red = 2x xp). Threat level used to determine the level (not the quality) of the drop before drops scaled to the player's level instead of the group level (e.g. - you needed all 51-52s to farm 51s; if a 55 was in the group everyone would get a 55 drop; but even with all 51-52s you had to kill enough mobs to lower the threat level for a 51 to drop).

Threat level does not determine drop quality.