Financial Integration in a Transition Economy: Evidence from Azerbaijan Using ARDL and VAR Approaches

Abstract

This study examines the degree and dynamics of Azerbaijan’s financial integration with global financial markets within a comprehensive theoretical and empirical framework. Building on classical theories of economic integration and contemporary literature on financial market integration, the paper conceptualizes integration as a gradual, multidimensional, and institutionally conditioned process rather than a binary outcome. Using time-series data from official national and international sources, the analysis employs a combined autoregressive distributed lag (ARDL) and vector autoregression (VAR) approach to capture both long-run equilibrium relationships and short-run dynamic interactions among key macro-financial variables. The empirical results provide robust evidence of long-run cointegration between Azerbaijan’s domestic financial indicators and global financial variables, indicating the existence of structural financial linkages. However, the magnitude of estimated coefficients and the speed of adjustment reveal a moderate and partial level of integration. Exchange rate dynamics emerge as the primary transmission channel of global financial conditions, while interest rate linkages remain comparatively weak. Short-run dynamics further show that external financial shocks propagate through the system in a controlled and non-disruptive manner. The study contributes empirical evidence from a transition economy and offers policy-relevant insights on balancing financial openness, stability, and market development.