The asymmetric relationship between financial development and CO2 emissions: the case of Pakistan

Abstract

The role of financial development for the environment has been extensively debated but the empirical results largely remain inconclusive. Empirical studies generally assume symmetric relationships, which can produce biased results. This study investigates the role of asymmetries in shaping the relationship of financial development (FD) with the environment by employing nonlinear autoregressive distributed lag (NARDL) model over the period 1972–2018. The structural unit root test of Zivot and Andrews indicates that all variables are integrated of order one and bound tests confirm long run relationship between the variables. The results validate the asymmetric association between FD and the environment as CO2 emissions are largely affected by negative shocks in FD in the short and long run. The dynamic multiplier analysis also supports the results by showing the dominance of a higher impact of a negative component of FD on carbon emissions than a positive component. This study concludes that assuming the symmetric effect of FD on CO2 emissions might be misleading. The study suggests that the policy makers may strive to achieve high growth rates using environmentally friendly financial development. Moreover, the negative asymmetric impact of FD needs to be considered in the development of financial sector.