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

Abstract

In this paper, we examine the downside risk associated with three different demographic subgroups: gender, income levels, and the education levels based on their consumer sentiment index (CSI) from the passive investment in the exchange-traded funds' (ETFs). We focus on the market capitalization-weighted and the equal-weighted S&P 500 ETFs risk-return forecast for different time horizons to find the impact of CSI on ETF market risk premium. The study presents future time horizons over which the changes in the CSI impact is statistically significant. Our findings support the loss aversion hypothesis of prospect theory that the changes in negative sentiment have a more powerful effect on the ETFs downside risk in comparison to the changes in positive sentiment. We present evidence that the downside risk is significant even in the passive ETF investment; however, investors can mitigate the downside risk by determining the appropriate investment horizons in their passive investing. Our results show that the risk associated with investor sentiment is short-lived (up to 18 months) depending upon the investors' demographic characteristics. We find that individual female investors are more risk-averse and have longer-lasting CSI influence in comparison to the individual male investors. The findings also show that the more educated the investors are, the stronger the impact of negative sentiment on the downside risk premium for ETF returns. However, in the case of income demographics, we find that the investors of medium-income levels have a higher and statistically significant CSI impact.

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

JEL Classification: G10, G11