Equity Premiums In a Small Open Economy

This paper studies the behaviour of asset prices in relation to consumption and other business cycle variables. While RBC models have been able to successfully explain the dynamics of macroeconomic variables, they fail to replicate similar interesting stylized facts when studying the behavior of asset prices. In an attempt to solve this shortcoming, some progress has been made in models that modify utility in order to account for habit persistence and incorporate capital adjustment costs. We have developed a framework that combines these ingredients by applying the loglinearly reduced form of the general equilibrium model and the asset pricing formula, based on the lognormality of the disturbance distribution for the small open economy case. Our ndings indicate that in a small open economy environment this kind of model fails to account for a substantial equity premium