Nexus Between Stock Market Development and Foreign Capital Flows: The Moderating Role of Liquidity

This paper examines the relationship between stock market development and foreign capital flows in nineteen emerging market economies, paying particular attention to the impact of market liquidity. In an era of heightened globalisation, emerging markets are becoming increasingly dependent on well-functioning stock markets to attract foreign capital. However, the mechanisms through which stock market development influences foreign capital inflows are not well understood. The present study aims to address this gap by explicitly incorporating liquidity as a key moderating factor in the nexus between stock market development and foreign capital flows. The present study employs secondary financial data spanning the period from 2005 to 2023 for a panel of selected emerging market economies. The analysis employs the General Method of Moments (GMM), Panel Autoregressive Distributed Lag (ARDL) and ECM modelling techniques. The results show that liquidity has a positive moderating effect on the relationship between stock market development and FDI, whereas illiquidity has the opposite effect. However, liquidity has no moderating effect on the relationship between stock market development and FPI. These results imply that policies that enhance liquidity in emerging markets are essential. Furthermore, a long-term relationship was found between liquidity and FDI, suggesting that improvements in stock market liquidity are likely to have a lasting impact on FDI.