What explains the investment growth anomaly?

► We test if an existing pricing model can explain the investment growth anomaly. ► We consider both unconditional and conditional model settings. ► We find that the conditional Fama–French 3-factor model can explain the anomaly. ► The model allows factor loadings to be time-varying. ► Factor loadings are also linked to firm characteristics and the business cycle. We examine if an existing asset pricing model in an unconditional or conditional setting can explain the investment growth anomaly, as represented by higher returns on stocks of the firms with lower growth in capital expenditures. Our results indicate that the conditional Fama–French 3-factor model that allows factor loadings to be time-varying and further linked to firm-level characteristics and the business cycle can explain the anomaly.