The Failure of Financial Econometrics: “Stir-Fry” Regressions as an Illustration

This paper demonstrates the hazard of “stir-fry” regressions, which are used extensively in financial research to produce desirable results by reporting only one or a small number of regressions out of the tens or hundreds that are typically estimated. It is shown, by using data on the capital structure of some Chinese shareholding companies, that the sign and significance of an estimated coefficient change with the set of explanatory variables and that adding more explanatory variables to the regression equation changes the sign and significance of a coefficient on a variable that is already included in the model. It is demonstrated that it is possible to change coefficients from significantly positive to significantly negative and vice versa and that obtaining the desirable results can be achieved by introducing various forms of nonlinearities. Finally it is shown that it is possible to support either the trade-off theory or the pecking order theory by changing model specification.