Regime Switching Effects of Banking and Stock Market Development on Carbon Emissions in Nigeria: New Evidence from the Markov-Switching Vector Autoregressive Approach

Abstract

Most existing studies on financial development and carbon emissions have typically been based on the assumption of invariant parameters, which makes it difficult to ascertain the actual condition of the former on the latter. The present study therefore provides new insight into the changing pattern of the effect financial development produces on carbon emissions, employing the Markov-switching vector autoregressive technique to obviate the assumed invariant parameters issue. Specifically, we analyse the regime-switching effect of the development of the two components of the financial sector, namely the stock market and banking, on carbon emissions in sub-periods within the entire sample. Our findings show a two-regime switching nature of the connection of the banking and stock market with carbon emissions. The stock market has a very weak moderating impact on carbon emissions. The result for the banking sector is not significant. The duration of regime 2 is shorter than regime 1 for the two components of the financial market. However, the duration is shorter for stock market development compared with the banking sector growth. Finally, the regime-dependent causality confirms unidirectional causality from the development of the banking and stock market to carbon emissions. Policymakers should emphasize the development of the financial sector to enhance environmental quality in Nigeria.