International interdependence of an emerging market: the case of Iran

In this study the interdependence between Iran, its major trading partners and the United States is investigated using vector autoregression, generalized impulse response function and generalized variance decomposition techniques, introduced by Pesaran and Shin (1998). These techniques have an advantage over the commonly used impulse response and variance decomposition procedures in that they are insensitive to the ordering of the countries considered and hence, they produce more reliable results. The countries included in the sample, besides Iran are, France, Germany, Spain, Japan, South Korea, Brazil, Italy and the United States. The direction, strength, durability and stability of the effect of shocks in one market on the return patterns of the other markets are examined. The findings are 4-fold. First, the effect of past own market shocks on current behaviour is significant, beyond the first month, in most cases. Second, the own effect is stronger for the emerging markets such as Iran and Brazil, than the industrialized countries. Third, cross-country effects are short-lived for Brazil, Korea and Japan, but durable in the case of Iran, Germany, Spain and the United States. Fourth, in terms of breadth and strength, cross-country effects exhibit differential degrees of interdependence and asymmetry. The observed lack of integration between the Iranian market and the industrialized world makes it less vulnerable to the effect of shocks in the latter countries but it also deprives it from the flow of funds that could spur economic development and growth.