Does foreign direct investments in financial services induce financial development? Lessons from emerging economies

Abstract

We employ panel Vector Error Correction Models (VECM) and cointegration framework to identify the existence and direction of the causal association between foreign direct investment (FDI) in financial services and financial development for 26 emerging economies for the period 2003–2015. Our results show that there exists a long‐run cointegrating relationship between financial development and FDI in financial services after incorporating the extent of heterogeneity among emerging economies. We find long run unidirectional causality from financial development to financial services FDI. Using fully modified OLS (FMOLS) estimation, we estimate the long run elasticities between financial services FDI and financial development. Our results show that financial development has a positive and significant impact on FDI in financial services, which implies that a country with well‐developed financial markets tend to attract larger amounts of FDI in financial services.