Financial development and business cycle volatility nexus in the UAE: Evidence from non‐linear regime‐shift and asymmetric tests

Abstract

AbstractThis paper analyses the dynamics of financial deepening and the volatility of business cycle in the United Arab of Emirates (UAE). We use cointegration tests of regime‐shift with one and two endogenous structural breaks, respectively, using Gregory and Hansen, Oxford Bulletin of Economics and Statistics, 1996, 58, 555–560 and Hatemi‐J, Empirical Economics, 2008, 35, 497–505 approaches. The asymmetry in the underlying relationship of the concerned variables are examined following NARDL model over the period 1974–2016. The findings suggest the presence of regime shifts in the cointegrating relationship and asymmetry between growth volatility and financial deepening. Furthermore, the paper provides evidence of a significant difference in the response of business cycle to negative or positive changes in the financial deepening, which are more pronounced in the short run. Therefore, the obtained asymmetry suggests that business cycle responses are quick and adverse to changes in the financial system in the UAE. The empirical findings of this paper have potential policy implications in this emerging country that is aiming to establish an international reputation in its financial market and become a regional financial hub.