Expecting the Unexpected and the Asset Growth Anomaly
F.Y. Eric C. Lam
Hong Kong Baptist University (HKBU) - Department of Finance and Decision Sciences; Hong Kong University of Science & Technology (HKUST) - Department of Finance
Kuo-Chiang (John) Wei
Hong Kong University of Science & Technology (HKUST) - Department of Finance
March 1, 2016
AFA 2013 San Diego Meetings Paper
The behavioral finance literature has suggested that both underreaction and overreaction, two seemingly contradictory mechanisms, can explain the total asset growth (TAG) anomaly. Using intangible TAG as a proxy for excessive investment, we show that underreaction in fact plays a relatively minor role. Instead, we find overreaction to be the principal driver of the anomaly when we use more informative fundamentals to construct TAG expectation inconsistency (TAGEI) as a proxy for extrapolative bias. TAGEI also provides a trading strategy that produces stronger returns and higher Sharpe ratios than the strategy based on the original TAG. These returns are even stronger when limits to arbitrage are more severe. TAGEI also helps synthesize other prominent anomalies related to capital investment. Anomalies related to working capital and external equity financing seem to be distinct from those related to capital investment.
Number of Pages in PDF File: 47
Keywords: Total asset growth; overreaction; underreaction; intangible total asset growth; total asset growth expectation inconsistency; corporate investment
JEL Classification: G14, G31, G32, M41, M42
Date posted: January 20, 2012 ; Last revised: March 9, 2016
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