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Ex-ante Expectation Errors and the Asset Growth Effect

Last Updated on 10 February, 2024 by Rejaul Karim

In the realm of financial exploration, FY Eric Lam and K.C. John Wei present a compelling voyage titled “Ex-ante Expectation Errors and the Asset Growth Effect,” showcased in a 40-page odyssey originating from the AFA 2013 San Diego Meetings.

Their work, a convergence of astute analysis, untangles the intricacies of ex-ante expectation errors, carving a path between sporadic and persistent total asset growth. Within this dichotomy, the profitability of high and low asset-growth firms performs a delicate dance, revealing the ebb and flow of ex-ante expectation errors. A magnetic force, the asset growth effect emerges robustly when expectation errors run high, yet dissipates into nonexistence when errors wane.

This phenomenon extends its influence steadfastly under various weightings, gaining potency amidst severe limits to arbitrage. The narrative unfolds further, unveiling the nuanced interplay between ex-ante expectation errors and the revision of analyst earnings forecasts.

Abstract Of Paper

We measure ex-ante expectation errors by identifying sporadic versus persistent total asset growth ex-ante. Corporate profitability of high (low) asset-growth firms remains inferior (superior) after temporary asset expansion (contraction), hence ex-ante expectation errors are high. Corporate profitability of high (low) asset-growth firms remains superior (inferior) along continual asset expansion (contraction), hence ex-ante expectation errors are low. The asset growth effect is strong when ex-ante expectation errors are high but nonexistent when ex-ante expectation errors are low. Ex-ante expectation errors remain important under value-weighting scheme and the influence is stronger when limits to arbitrage are more severe. Ex-post revision of analyst earnings forecast in an opposite direction to the change in asset size is larger when ex-ante expectation errors are higher. Ex-ante expectation errors uniformly affect return effects associated with a variety of asset change measures based on capital investment activity but they have little effect on return effects related to net working capital and external financing.

Original paper – Download PDF

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Author

FY Eric Lam
Independent Researcher

K.C. John Wei
Hong Kong Polytechnic University

Conclusion

In conclusion, this investigation sheds light on the intricacies of ex-ante expectation errors and their correlation with the asset growth effect.

The distinction between sporadic and persistent total asset growth ex-ante reveals a compelling pattern wherein high expectation errors coincide with inferior corporate profitability during temporary asset expansion and consistently superior profitability during continual asset expansion.

This relationship gains prominence in contexts marked by severe limits to arbitrage, emphasizing the contextual influence on ex-ante expectation errors. The study extends its insights to underscore the pervasive impact of expectation errors on return effects related to diverse asset change measures, providing a comprehensive perspective on how these errors intertwine with the dynamics of asset growth and stock returns.

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FAQ

Q1: What is the main focus of the research paper “Ex-ante Expectation Errors and the Asset Growth Effect” by FY Eric Lam and K.C. John Wei?
A1: The research delves into the relationship between ex-ante expectation errors and the asset growth effect. It distinguishes between sporadic and persistent total asset growth ex-ante, revealing a nuanced pattern where high expectation errors coincide with inferior corporate profitability during temporary asset expansion and consistently superior profitability during continual asset expansion.

Q2: How does the asset growth effect vary based on the levels of ex-ante expectation errors?
A2: The asset growth effect is robust when ex-ante expectation errors are high, but it becomes nonexistent when these errors are low. The profitability of high and low asset-growth firms performs differently based on the ebb and flow of ex-ante expectation errors, indicating a dynamic correlation between the two phenomena.

Q3: In what contexts does the study suggest that ex-ante expectation errors play a more significant role in influencing the asset growth effect?
A3: The study emphasizes that the influence of ex-ante expectation errors is stronger in contexts marked by severe limits to arbitrage. This underscores the contextual dependence of expectation errors on the asset growth effect. The research also extends its insights to demonstrate the pervasive impact of expectation errors on return effects related to various asset change measures, offering a comprehensive perspective on their intertwining dynamics.

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