Stochastic conditional convergence of financial development: new insights based on RALS-LM and LM unit root tests with breaks

Purpose This study aims to examine the stochastic conditional convergence of financial development (FD) using both time series and panel frameworks for emerging South Asian countries over the period 1990–2020. In contrast to existing studies that predominantly rely on a single proxy for FD, this study constructs a comprehensive FD index to ensure a robust measurement. Design/methodology/approach The analysis uses unit root testing methodologies within both time series and panel frameworks with structural breaks. Additionally, principal component analysis (PCA) is used to construct a robust FD index. Findings The results from both analysis frameworks indicate that FD across all SAARC affiliates conditionally converges toward the average FD of SAARC region. Furthermore, the identified structural breaks align with major macroeconomic events in these countries. Originality/value To the best of our knowledge, this study is the first attempt to address the stochastic conditional convergence within both time series and panel frameworks for SAARC countries. Following the approach of Evans and Karras (1996), this study highlights that overlooking structural breaks may obscure the convergence process. By incorporating structural breaks into unit root testing methodologies, this study provides more comprehensive understanding of FD dynamics. Moreover, the use of PCA to construct a FD index enhances the robustness of the measurement, thereby contributing to the existing literature on FD and convergence.