Is there an asymmetric link between the shadow economy and the financial depth of emerging market economies?

This study investigates the relationship between the shadow economy and financial depth for a group of 17 selected emerging countries over the period of 1980–2018 in both the long-run and short-run. The main feature of this study is to distinguish the short-run effects of the shadow economy from its long-run impacts by using the bounds testing approach to cointegration and error-correction modeling. Using a linear model estimation approach (ARDL), our findings show that, in a majority of countries, the existence of the shadow economy has a significant adverse impact on financial depth, implying that with an uncertain financial environment, there will be less opportunity to have a developed financial sector for this group of emerging market economies. Using the non-linear model estimation approach (NARDL), to investigate this relationship, we provide robust statistical evidence that the effect of the shadow economy on the depth of financial market development is not symmetric. The results indicate that despite similarities as emerging market economies, the estimated results could be very much country-specific in terms of unique country characteristics.