Betting on Total Asset Growth Reversal: The Role of Style Investing and Extrapolation Bias

We examine implications of investors’ extrapolation bias combined with irrational demand for stocks based on asset growth categorization and fund reallocation driven by migration of stocks across these salient styles. The conventional long-short strategy is essentially a simple bet on cross-sectional mean reversion in asset growth, which is a necessary condition for the asset growth effect. When the initial sign of asset growth reversal is strong (weak) prior to the holding period, the asset growth effect is weak (strong). Finally, when past information is incorporated to improve the signal of asset growth reversal, the asset growth effect more than doubles.