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This study examines the effect of outliers on causal relationship between financial development and economic growth using 48 countries from 1988 to 2014. The dynamic panel model of Levine, Loayza, and Beck (2000) is used to examine this issue. We propose a novel approach by combining the least square dummy variable correction method (LSDVC) to remove the estimates bias in the dynamic panel model and the least trimmed squares (LTS) to control outlier influence. The combination of these two methods is referred to as LSDVC + LTS. Our results show a counter-intuitive evidence that bank development negatively affects economic growth when the outlier influence is ignored. This counter-intuitive evidence holds even when the conventional winsorization method is used to control the outliers. However, bank development exhibits a positive influence on economic growth once the proposed approach LSDVC + LTS is adopted. Also, stock market development exhibits a positive effect on economic growth regardless of the outliers.
Shen et al. (Wed,) studied this question.