Consumer Sentiment, Demographics, and Downside Risk: Evidence from Passive Investment

Abstract

This paper examines the downside risk of passive investment based on investor demographics. We use the consumer sentiment index (CSI) to measure the downside risk tolerances of different demographic subgroups. We focus on the S&P 500 ETFs risk-return forecast for different time horizons to find the impact of CSI on ETF's market risk premium. Our study presents future time horizons over which the changes in the CSI impact are statistically significant. The empirical results support the loss aversion hypothesis of prospect theory that the changes in negative sentiment have a more powerful effect on the ETF's downside risk than the changes in positive sentiment. We present evidence that the downside risk is significant even in the passive investment; however, investors can mitigate the downside risk by determining the appropriate investment horizons in their investing. Our results show that the risk associated with investor sentiment is short-lived (up to 12 months) depending upon the investors' demographic characteristics.

Keywords: CSI, Demographics, Downside Risk, Passive ETFs, Prospect Theory, Loss Aversion

JEL Classification: G10, G11