Abstract
We use consistency between extrapolative and informed expectations to test for the role of ex ante expectation errors in the asset growth anomaly and add new evidence for the mispricing explanation. We find that ex ante expectation errors are critical to the asset growth anomaly as well as to anomalies based on other capital investment measures. Our refined asset growth strategy is tradable and delivers stronger abnormal returns and Sharpe Ratios than the ordinary asset growth strategy. Our approach reconciles with the observed composition of the abnormal return spreads, addresses the connection between growth reversal and the anomaly, and is compatible with the profitability premium. We are also able to generate findings related to firm size, limits to arbitrage, and earnings announcements that are in line with those in the literature.
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