Time–frequency dependency of financial risk and economic risk: evidence from Greece
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This study aims to shed some light on the one of the most popular phenomena in the economics and finance literature—nexus between economic growth and financial development—for the case of Greece over 1990Q1 to 2018Q4 within the framework of risk. In other words, this study investigates the causal link between financial risk and economic risk in Greece using wavelet coherence tests while answering the following questions: (i) does financial risk lead to economic risk in Greece and/or does economic risk lead to financial risk in Greece, and (ii) if so, why? The wavelet coherence approach allows the study to capture the long-run and short-run causal linkages among the time series variables since the approach combines time and frequency domain causalities. The findings from wavelet coherence supports the Schumpeter hypothesis since the findings proves that there is unidirectional causality from financial risk to economic risk in Greece (i) between 1995 and 1998; (ii) between 2003 and 2013; (iii) between 2013 and 2017 at different frequency levels. The findings clearly reveal how financial risk is important predictor for economic risk in Greece over the period of 1990–2018.
KeywordsFinancial risk Economic risk Greece Wavelet coherence Causality
Since the innovative theoretical study of Schumpeter (1911), considerable attention has been drawn to the nexus between financial development and economic growth. Globally, this nexus has remained one of the most important research topics in the last ten decades. To open new debate in the literature within the risk framework, co-movement between economic risk and financial risk in Greece is explored using wavelet coherence approach. The approach allows the present study to capture the short term and long term relationship among the time series variables since the decomposition of one-dimensional time data into the bi-dimensional time–frequency sphere is allowed with the wavelet coherence approach.
To best of my knowledge, the present study is the first to investigate in detail the short term and long term linkages between economic risk and financial risk for the case of Greece. It is important for policymakers to know whether there is any causal linkage between financial risk and economic risk in either developed or developing countries. Even, it is more important for Greece where the country is hit by the 2007–2008 global crisis and faced by the domestic debt crisis between 2009 and 2012. As widely accepted, Greece’ debt crisis triggered the political instability and social exclusion in Greece, even thousands of well-educated Greeks have left the country due to dramatically rising unemployment rate, especially for young generation. The Greek government announced a series of austerity measures within the framework of bailout programmes—First, Second and Third Economic Adjustment Programme between 2010, May and 2018, August. Therefore, the causal linkage between financial risk and economic risk is vital for policymakers in Greece because it has expressly different implications for development policy.
In the literature, scholars have tested three different hypotheses: (1) supply-leading hypothesis—(is called “finance-led growth”), (2) demand-leading hypothesis (is called “growth-led finance”), and (3) feedback linkage between economic growth and financial development. While the supply-leading hypothesis of Schumpeter (1911) is well-documented by Goldsmith (1969), King and Levine (1993), Neusser and Kugler (1998), Rajan and Zingales (2003), Levine et al. (2000), and Beck et al. (2000), demand-leading hypothesis is theoretical or empirical supported by Robinson (1952), Gurley and Shaw (1967), Goldsmith (1969), and Jung (1986). Moreover, since the initial attempt of the Patrick (1966), the feedback relationship between economic growth and financial development has been shed light by the studies of Demetriades and Hussein (1996), Greenwood and Smith (1997), Aretsis and Demetriades (1997), Arestis et al. (2001), Al-Yousif (2002), Wolde-Rufael (2009), Hassan et al. (2011), Rousseau and Wachtel (2011), Yu et al. (2012), and Cecchetti and Kharroubi (2012).
Cournède and Denk (2015) aimed to investigate the effect of financial development on long-run economic development. They found supportive empirical evidence for the supply-leading hypothesis in the OECD and G20 countries. They argued that financial development played a significant role in accelerating economic growth by increasing the availability of loanable funds, improving resource allocation, increasing efficiency in capital allocation, and reducing adjustment cost due to higher demand in the market. Moreover, Madsen and Any (2016) also support the finance-led growth hypothesis while underlining the financial development causes economic growth through four channels, including production, savings, fixed investment, and schooling in 21 OECD countries. A more recent study of Asteriou and Spanos (2019) explored the nexus between financial development and economic growth in the EU over the period of 1990–2016. They conclude that although at the pre period of the global crisis, economic growth was triggered by financial developed, the effect turned into negative during the global crisis period. In addition, “during the recent sub-prime crises the capital adequacy of banks promoted the stability the financial system” (Asteriou and Spanos 2019). On the other hand, the studies of Rousseau and Wachtel (2002) and Demetriades and Law (2006) underline that “expanding financial instruments and developing financial systems do not play a significant role in fostering economic growth” (Kirikkaleli 2016).
However, Ndlovu (2013) demonstrated the relationship between financial sector development and economic growth, finding unidirectional causality from economic growth to financial development in Zimbabwe. In addition, Pan and Mishra (2018) explore the relationship between stock market and economic growth in China using the ARDL and Toda Yamamoto causality tests. They find that changes in economic growth significantly cause financial development, especially the Shenzhen B stock market. The study of Bist (2018) focuses on 16 selected low-income countries in Africa for the period of 1995 to 2014 and also supports the growth-led finance hypothesis, empirically.
However, existing empirical and theoretical studies in the economics and finance literatures reveal that there is no exact answer for the direction of this relationship. The direction of causality among the variables, if they exist, have changed from one study to another due to focusing on a different country or countries, focusing on different time periods, or even using different techniques. Even, there are quite limited numbers of studies specifically have focused on the case of Greece. Dritsakis and Adamopoulos (2004) examined the nexus in Greece using the VAR model over the period of 1960 to 2000 on a quarterly basis. They concluded that the feedback causal linkage between the economic growth and financial development exist since they observed the presence of common trend among these variables. Hondroyiannis et al. (2005) examines empirically the causal relationship between economic growths, the development of the banking system and the stock market in Greece and they underline the importance of bank and stock market financing on the economic performance of Greece in the long-run. Dritsaki and Dritsaki-Bargiota (2005) explore the triangle between financial development, credit market and economic growth in Greece. They underscore that while there is long-run relationship among the variables, there is unidirectional causal linkage from economic growth to stock market development and there is two-way causal relationship between banking sector development and economic growth.
2 Data and methodology
Data and descriptive statistics
Economic risk index
Financial risk index
Political risk services group
Political risk services group
1990Q1 to 2018Q4
The period of 1990 and 1998, the economic environment of Greece was worse relative to financial one and in this time period, Greece found position itself from very high risky environment to high risk environment in terms of economic performance. As demonstrated in Fig. 1, between 1999 and the beginning of the global crisis, due to mainly rising the debt of GDP ratio kept Greece in a moderate risk in terms of finance while economic risk was relatively better. Erupting the global crisis, political vulnerabilities, cutting Greece’ credit rating by the credit agencies in the world apart from leading domestic crisis in Greece, also increased the both economic risk and financial risk levels. Although economic risk in Greece was in downward trend between 2013 and 2018, financial risk level remained in the high risk environment, as seen in Fig. 1 in the orange shaded area. This clearly shows that finance system in Greece still risky and the report of the European Union Statistics Office confirms this since the office announce that government debt ratio in Greece reached 181.1% of the nation’s GDP which broke the records in an all-time high.
The present study examines the co-movement between financial risk and economic risk in Greece using the wavelet approach initially developed by Goupillaud et al. (1984). The main innovation of wavelet techniques appears where the decomposition of one-dimensional time data into the bi-dimensional time–frequency sphere is allowed. This allows the present study to capture the long-run and short-run causal linkages between the variables. A multi-scale decomposition method brings out a natural framework to show frequency-dependent behaviour for investigating the linkage between economic risk and financial risk in Greece.
3 Empirical finding
The present study aims to explore co-movement between economic risk and financial risk over the period of 1990Q1 to 2018Q4 in Greece using wavelet coherence approach. The empirical findings reveal that changes in financial risk significantly lead to changes in economic risk in Greece. Actually, this is rational and in line with the expectation. Therefore, to achieve economic stability in Greece; governors should have a sound financial environment. In other words, foreign debt, liquidity, trade, and exchange rate need to be controlled in Greece to minimize economic instability in the market. Since the present study clearly underlines the importance of financial risk over the economic risk in Greece, increasing debt GDP ratio to over 181% in 2018 might be disturb the macroeconomic dynamics in the market in the near future if there will be any global and regional uncertainties. Therefore, the outcome strongly suggests for the incumbent government in Greece to implement policies for facilitating economic growth and reducing debt as a percentage of GDP. Although the present study makes it possible to identify strong empirical findings, further studies should be conducted for the other Southern European economies.
The author read and approved the final manuscript.
I also confirmed that this research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.
The author declares that he has no competing interests.
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