Growth Opportunity Bias

Growth opportunity bias (GOB), measured as the difference between market and fundamental values of a firm’s growth opportunity, has an ability to predict future stock returns. In the portfolio sort, downward-biased GOB firms earn higher returns than upward-biased GOB firms, which is unexplained by the common asset pricing models. Cross-sectional regression results also confirm GOB’s power in predicting stock returns. To explain the anomaly, we show that the GOB premium is more pronounced when investor sentiment is high or when limits-to-arbitrage is severe, which suggests that the GOB is more likely to capture behavioral biases than systematic risk.