The Impact of Interaction Effects among Neighbouring Countries on Financial Liberalization and Reform: A Dynamic Spatial Panel Data Approach

Abstract

Using data from Abiad et al . (2008), we estimate a dynamic spatial panel data model with country and time-period fixed effects to test for spatial cointegration in the financial liberalization index. Parameter estimates are obtained by reformulating the model in spatial first-differences. Next, by considering the error correction model representation of the dynamic spatial panel data model, we examine financial reform interaction effects and the extent to which a change in a single explanatory variable in a particular country affects financial reform in other countries. Finally, by comparing the performance of different specifications of the spatial weights matrix describing the spatial arrangement of the countries in the sample, we show that the popular regional leader matrix must be rejected in favour of an inverse distance matrix with a cut-off point of 3, 000 km.