Investigating the financial market development and shadow economy nexus in the presence of country risk in an emerging economy

This research study examined the influence of financial market development on the shadow economy and the moderating effect of country risk (political, economic, and financial) in this nexus in Pakistan. Using data from 1995 to 2018, the study applied the Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) unit root tests, followed by the F-bounds test to investigate stationarity and cointegration in the series, respectively. The study utilized the Autoregressive Distributed Lag (ARDL) approach to estimate the long-run relationship, and to examine the possible causal relationship among the variables, the study employed Breitung and Candelon's (2006) spectral test. The study identified that financial market development is negative, and the country's risk determinants are positively associated with the shadow economy's size. Moreover, the study found that country risk positively moderates the influence of financial market development on the shadow economy. The results also highlighted a unidirectional relationship from economic and financial risk towards the shadow economy. Finally, based on the empirical findings, the study recommends some policy implications to the regulators of financial markets and the shadow economy.

Automated summary

This research study investigated the impact of financial market development on the shadow economy in Pakistan, with a focus on the moderating effect of country risk. The study utilized various tests and approaches to analyze the data from 1995 to 2018. The findings indicated a negative relationship between financial market development and the size of the shadow economy, while country risk was found to positively moderate this relationship. The study also identified a unidirectional relationship from economic and financial risk towards the shadow economy. Policy implications were recommended based on the empirical findings.