Nexus between Financial Liberalization and Financial Market Performance: A Testing of Convergence Hypothesis

Shahzad, Sadia and Audi, Marc and Sulehri, Fiaz Ahmad and Ali, Amjad (2025): Nexus between Financial Liberalization and Financial Market Performance: A Testing of Convergence Hypothesis.

Abstract

This paper investigates the impact of financial liberalization, economic growth, and political instability on financial market performance from 1990 to 2021. The dependent variable is financial market performance, while financial liberalization, economic growth, and political instability are treated as independent variables. Monetary and fiscal freedom are included as control variables. The study employs various empirical methods, including descriptive statistics, correlation matrices, panel least squares, and panel autoregressive distributed lag models. Monetary freedom exhibits a statistically insignificant negative effect on financial market performance. In contrast, fiscal freedom shows a strong negative correlation with financial market performance. Financial liberalization has a statistically significant positive effect on financial market performance. Economic growth also exerts a substantial positive impact on financial market performance. Political instability, however, has a statistically significant negative influence on financial market performance. These findings lend support to the convergence hypothesis. Policymakers must strike a balance between regulatory intervention and market autonomy. This can be achieved by implementing policies that promote fiscal freedom, eliminate unnecessary constraints on economic activity (particularly in the financial sector), and encourage greater financial sector openness. Additionally, policies should prioritize economic growth through investment promotion, support for innovation, facilitation of entrepreneurship, and infrastructure development.

• Item Type: MPRA Paper
• Language: English
• Keywords: financial liberalization, financial market performance, convergence hypothesis
• Subjects: F - International Economics > F3 - International Finance; G - Financial Economics > G2 - Financial Institutions and Services

References

Adjasi, C. K., & Yu, D. (2021). Investigating South Africa's economic growth: The role of financial sector development. Journal of Business and Economic Options, 4(3), 19-29.

Ahmed, A. D. (2013). Effects of financial liberalization on financial market development and economic performance of the SSA region: An empirical assessment. Economic Modelling, 30, 261-273.

Ahmed, A. D. (2016). Integration of financial markets, financial development and growth: Is Africa different? Journal of International Financial Markets, Institutions and Money, 42, 43-59.

Ahmed, A. D., & Mmolainyane, K. K. (2014). Financial integration, capital market development and economic performance: Empirical evidence from Botswana. Economic Modelling, 42, 1-14.

Ahmed, J., & Alvi, A. A. (2024). The Role of Financial Inclusion in Shaping Labor Market Outcomes in Emerging Economies. Journal of Business and Economic Options, 7(4), 33-41.

Ahmed, J., & Rura, H. (2024). Understanding Heuristics and Investor Behavior in Financial Markets. Journal of Policy Options, 7(4), 22-29.

Aisen, A., & Veiga, F. J. (2013). How does political instability affect economic growth? European Journal of Political Economy, 29, 151-167.

Ake, B. (2010). The role of stock market development in economic growth: evidence from some Euronext countries. International Journal of Financial Research, 1(1), 14-20.

Alesina, A., & Perotti, R. (1996). Fiscal discipline and the budget process. The American Economic Review, 86(2), 401-407.

Alesina, A., & Perotti, R. (1996). Income distribution, political instability, and investment. European economic review, 40(6), 1203-1228.

Alesina, A., & Tabellini, G. (1990). A positive theory of fiscal deficits and government debt. The review of economic studies, 57(3), 403-414.

Alesina, A., Özler, S., Roubini, N., & Swagel, P. (1996). Political instability and economic growth. Journal of Economic Growth, 1(2), 189–211.

Ali, A. (2022). Determining Pakistan's Financial Dependency: The Role of Financial Globalization and Corruption. Journal of Business and Economic Options, 5(1), 24-38.

Ali, A. (2022). Financial Liberalization, Institutional Quality and Economic Growth Nexus: Panel Analysis of African Countries. Bulletin of Business and Economics (BBE), 11(3), 37-49.

Ali, A. (2022). Foreign Debt, Financial Stability, Exchange Rate Volatility and Economic Growth in South Asian Countries. Journal of Business and Economic Options, 5(4), 26-34.

Ali, A., & Sajid, A. (2020). Towards Inclusive Growth: Financial Sector Dynamics and Poverty Reduction in Pakistan. Journal of Business and Economic Options, 3(4).

Ali, S. B., & Mohsin, A. (2023). Exploring financial soundness and economic growth dynamics in Pakistan. Journal of Business and Economic Options, 6(1), 1-15.

Al-Yousif, Y. K. (2002). Financial development and economic growth: another look at the evidence from developing countries. Review of financial economics, 11(2), 131-150.

Andersen, T. B., & Tarp, F. (2003). Financial liberalization, financial development and economic growth in LDCs. Journal of International Development: The Journal of the Development Studies Association, 15(2), 189-209.

Andrianaivo, M., & Yartey, C. A. (2010). Understanding the growth of African financial markets. African Development Review, 22(3), 394-418.

Anwar, S., & Nguyen, L. P. (2011). Financial development and economic growth in Vietnam. Journal of Economics and Finance, 35(3), 348-360.

Audi, M., & Yu, H. (2024). Strategic Value Creation Through Corporate Social Responsibility Adoption for Sustainable Financial Performance. Journal of Policy Options, 7(4), 14-21.

Audi, M., Poulin, M., Ahmad, K., & Ali, A. (2025). Quantile Analysis of Oil Price Shocks and Stock Market Performance: A European Perspective. International Journal of Energy Economics and Policy, 15(2), 624-636.

Bekaert, G., & Harvey, C. R. (2000). Foreign speculators and emerging equity markets. Journal of Finance, 55(2), 565–613.

Bekaert, G., Harvey, C. R., & Lundblad, C. (2005). Does financial liberalization spur growth? Journal of Financial Economics, 77(1), 3–55.

Bekaert, G., Hoerova, M., & Duca, M. L. (2013). Risk, uncertainty and monetary policy. Journal of Monetary Economics, 60(7), 771–788.

Bozic, I., & Bozic, A. (2025). Commercial Banking and Financial Stability: Evaluating Internal and External Determinants. Journal of Business and Economic Options, 8(1), 1-14.

Campos, N. F., & Nugent, J. B. (2002). Who is afraid of political instability? Journal of Development Economics, 67(1), 157–172.

Dahmani, L., & Makram, H. (2024). Fostering Economic Growth Through Financial Stability in Sub-Saharan Africa. Journal of Business and Economic Options, 7(4), 13-22.

Durusu-Ciftci, D., Ispir, M. S., & Yetkiner, H. (2017). Financial development and economic growth: Some theory and more evidence. Journal of Policy Modeling, 39(2), 290–306.

Eichengreen, B., & Hausmann, R. (1999). Exchange Rates and Financial Fragility. NBER Working Paper, (w7418).

Engle, R. F., & Granger, C. W. (1987). Co-integration and error correction: representation, estimation, and testing. Econometrica: journal of the Econometric Society, 251-276.

Engle, R. F., & Granger, C. W. J. (1987). Co-integration and error correction: Representation, estimation, and testing. Econometrica, 55(2), 251–276.

Fatima, N., & Zaman, A. (2020). Financial development, innovation, and economic growth: Evidence from developing countries. Journal of Policy Options, 3(2).

Granger, C. W. (1981). Some properties of time series data and their use in econometric model specification. Journal of econometrics, 16(1), 121-130.

Greenwood, J., & Smith, B. D. (1997). Financial markets in development, and the development of financial markets. Journal of Economic Dynamics and Control, 21(1), 145–181.

Henisz, W. J. (2000). The institutional environment for multinational investment. Journal of Law, Economics, and Organization, 16(2), 334–364.

Huseyin, E. (2023). Financial Performance Metrics in Family vs Non-Family CEOs of Family-Owned Firms. Journal of Policy Options, 6(2), 1-8.

Idris, O. (2023). Discussion on the Role of Emotional Intelligence in Financial Decision-Making. Journal of Policy Options, 6(4), 20-29.

Iqbal, A. (2018). Determinants of Micro Finance in Pakistan. Journal of Business and Economic Options, 1(1), 15-22.

Ismail, H., & Saeed, A. (2019). Islamic banking and finance in Pakistan: Growth trends, outlook, and strategic imperatives. Journal of Policy Options, 2(4).

Jammazi, R., & Mokni, K. (2021). Enhancing Risk Management Practices: Insights from VAR Forecasting in Financial Markets. Journal of Business and Economic Options, 4(1), 1-9.

Kar, S., & Dasgupta, S. (2024). Strategies to Mitigate Financial Fraud Through Intellectual Capital Management. Journal of Policy Options, 7(4), 38-47.

Khan, M. A. (2022). The impact of earnings management on financial metrics: Insights from Pakistani firms. Journal of Business and Economic Options, 5(3), 34-43.

Khan, M. S., & Senhadji, A. S. (2000). Financial development and economic growth: An overview. SSRN.

Kovalenko, V. V., Bolgar, T. M., Yevtushenko, O. A., & Pestovska, Z. S. (2019). Competitiveness of banks in the modern conditions of financial market development. Financial and Credit Activity Problems of Theory and Practice, 2(29), 3–12.

La Porta, R., & Lopez-de-Silanes, F. (1998). Capital markets and legal institutions. Beyond the Washington Consensus: Institutions Matter, 73–92.

Levine, R. (1997). Financial development and economic growth: views and agenda. Journal of Economic Literature, 35(2), 688–726.

Levine, R. (2005). Finance and growth: Theory and evidence. In Handbook of Economic Growth (Vol. 1B, pp. 865–934). Elsevier.

Levine, R., & Zervos, S. (1996). Stock market development and long-run growth. The World Bank Economic Review, 10(2), 323–339.

Levine, R., & Zervos, S. (1998). Stock markets, banks, and economic growth. American Economic Review, 537–558.

Levine, R., & Zervos, S. (1998). Stock markets, banks, and economic growth. American Economic Review, 88(3), 537–558.

Mbodj, A., & Laye, S. (2025). Reducing Poverty Through Financial Growth: The Impact of Financial Inclusion and Development in Emerging Economies. Journal of Business and Economic Options, 8(1), 61-76.

Mishkin, F. S. (2007). Inflation dynamics. International Finance, 10(3), 317–334.

Munir, Q., Akram, B., & Abbas, S. A. (2024). Understanding Stock Price Dynamics with Dividend-Related Metrics and Financial Indicators in Pakistan's Non-Financial Sectors. Journal of Business and Economic Options, 7(1), 1-9.

Musa, A. (2024). Impact of Ownership Structures on Financial Performance and Distress in Businesses. Journal of Policy Options, 7(3), 30-38.

Neyapti, B. (2003). Budget deficits and inflation: the roles of central bank independence and financial market development. Contemporary Economic Policy, 21(4), 458–475.

Niroomand, F., Hajilee, M., & Al Nasser, O. M. (2014). Financial market development and trade openness: Evidence from emerging economies. Applied Economics, 46(13), 1490–1498.

Omri, M. B. (2022). Understanding the relationship between liquidity and banking financial stability in Islamic and conventional banks. Journal of Business and Economic Options, 5(1), 39-47.

Rajan, R., & Zingales, L. (1998). Financial development and growth. American Economic Review, 88(3), 559–586.

Romer, C. D., & Romer, D. H. (2010). The macroeconomic effects of tax changes: Estimates based on a new measure of fiscal shocks. American Economic Review, 100(3), 763–801.

Roy, S., & Madheswaran, S. (2020). The Nexus between Financial Sector Development and Economic Growth: Evidence from Asian Countries. Journal of Business and Economic Options, 3(2).

Sever, C. (2019). Exploring Model-Based Approaches to Contagion in Global Financial Markets: A Survey. Journal of Business and Economic Options, 2(4).

Shen, C. H., & Lee, C. C. (2006). Same financial development yet different economic growth: why? Journal of Money, Credit and Banking, 1907–1944.

Soumaré, I., & Tchana Tchana, F. (2015). Causality between FDI and financial market development: Evidence from emerging markets. The World Bank Economic Review, 29(suppl_1), S205–S216.

Sulehri, F. A., Khalid, M. J., Ali, A., Shahzadi, S., Azam, H., Akram, A., & Bukhari, S. A. F. (2025). Unveiling Key Drivers of Financial Distress in Developing Economies: A Comprehensive Analysis. Contemporary Journal of Social Science Review, 3(1), 665-678.

Sumaira, (2020). The Dual Impact of Remittances and Financial Development on Environmental Pollution: Evidence from South Asian Countries. Journal of Policy Options, 3 (3), 75-81.

Tansuchat, P., & Thaicharo, Y. (2025). Cognitive Biases and Investment Choices: Exploring the Psychological Determinants of Financial Decision-Making in Thailand. Journal of Business and Economic Options, 8(1), 43-60.

Thangavelu, S. M., & Beng Jiunn, A. (2004). Financial development and economic growth in Australia: An empirical analysis. Empirical Economics, 29(2), 247–260.

van Zanden, J. L. (2023). Examining the relationship of information and communication technology and financial access in Africa. Journal of Business and Economic Options, 6(3), 26-36.

Wali, R. M. (2018). Analysis of Financial Ratios and Credit Risk Ratings in the Banking Industry: Insights and Findings. Journal of Business and Economic Options, 1(2), 52-59.

Wang, J., & Huang, M. (2024). Dynamics of South Asian Stock Exchanges and Their Global Interactions During and After the Financial Crisis. Journal of Policy Options, 7(3), 20-29.

Ziolo, M., Fidanoski, F., Simeonovski, K., Filipovski, V., & Jovanovska, K. (2017). Sustainable finance role in creating conditions for sustainable economic growth and development. Sustainable Economic Development: Green Economy and Green Growth, 187–211.

Zubair, I., & Hayat, A. (2020). Financial Development and Poverty Reduction: Insights from Pakistan. Journal of Business and Economic Options, 3(4).