Equity Premiums In Small Open Economy

It is now well known that the RBC models have enjoyed successful results in explaining the dynamics of the business cycle variables but fail to replicate similar interesting stylized facts while studying the behavior of asset prices. One line of progress for solving this shortcoming has been to modify utility to account for habit persistence and to incorporate capital adjustment costs. This paper study a small open economy general equilibrium model along with asset pricing formula based on the lognormality of the disturbance distribution. Our results stipulate that extending models with habit forming preferenses and capital adjustment cost fails to account for a substantial equity premium in a small open economy environment