Financial development is one of the key drivers of rapid economic growth as well as CO2 emission in the environment. This study aims to investigate the casual links between financial development and CO2 emission in G8 and D8 countries for the time period from 1999 to 2013. We used PCA to develop financial development index from its five sub-components. Second-generation panel unit root tests are applied to check the stationary level and to tackle the presence of cross-sectional dependence in panels. The empirical results of PMG-panel ARDL technique show that financial development has significant and positive impact on carbon emission at a 1% statistical level in both panels in the long-run. The impact of financial development and energy consumption is more evident in D8 and G8 countries respectively. The energy use and trade openness affect positively while GDP significantly causes to decline the carbon emissions at 1% statistical level. The results of D-H causality test show that majority of the variables have one-way causality towards CO2emission in both panels except the financial development and energy use having two-way causality in G8 panel only. The empirical findings of the present study suggest that through improved financial system, more funds should be invested in clean energy projects to adopt the renewable energy, strict monetary policies should be implemented to reduce the consumption of big ticket items, and adoption of measure to reduce trade embodied emission is suggested.
Keywords: CO2 emission; D8 and G8 countries; Financial development; PMG-Panel ARDL.