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Equity Premiums In a Small Open Economy

  • Douch, Mohamed

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.

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File URL: https://mpra.ub.uni-muenchen.de/876/1/MPRA_paper_876.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 876.

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Date of creation: Jun 2004
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Handle: RePEc:pra:mprapa:876
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  1. Michele Boldrin & Lawrence J. Christiano & Jonas D.M. Fisher, 1995. "Asset Pricing Lessons for Modeling Business Cycles," NBER Working Papers 5262, National Bureau of Economic Research, Inc.
  2. Bennett T. McCallum & Edward Nelson, 2000. "Nominal Income Targeting in an Open-Economy Optimizing Model," NBER Working Papers 6675, National Bureau of Economic Research, Inc.
  3. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March.
  4. Rouwenhorst, K.G., 1991. "Asset Returns and Business Cycles," Papers 40, Rochester, Business - Ph.D.,.
  5. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
  6. Lettau, Martin & Uhlig, Harald, 1997. "Preferences, Consumption Smoothing, and Risk Premia," CEPR Discussion Papers 1678, C.E.P.R. Discussion Papers.
  7. Abel, Andrew B., 1980. "Empirical investment equations : An integrative framework," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 12(1), pages 39-91, January.
  8. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  9. Shmuel Kandel & Robert F. Stambaugh, 1991. "Asset Returns and Intertemporal Preferences," NBER Working Papers 3633, National Bureau of Economic Research, Inc.
  10. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, vol. 83(3), pages 487-512, June.
  11. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
  12. John Y. Campbell, 1984. "Bond and Stock Returns in a Simple Exchange Model," NBER Working Papers 1509, National Bureau of Economic Research, Inc.
  13. Olivier Allais & Loic Cadiou & Stéphane Dees, 2000. "Consumption Habit and Equity Premium in the G7 Countries," Working Papers 2000-19, CEPII research center.
  14. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  15. Lettau, M. & Uhlig, H.F.H.V.S., 1997. "Preferences, Consumption Smoothing and Risk Premia," Discussion Paper 1997-60, Tilburg University, Center for Economic Research.
  16. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
  17. Mendoza, Enrique G. & Uribe, Martin, 2000. "Devaluation risk and the business-cycle implications of exchange-rate management," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 239-296, December.
  18. Danthine, Jean-Pierre & Donaldson, John B. & Mehra, Rajnish, 1992. "The equity premium and the allocation of income risk," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 509-532.
  19. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  20. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
  21. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  22. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  23. Bennett T. McCallum & Edward Nelson, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," NBER Working Papers 8175, National Bureau of Economic Research, Inc.
  24. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  25. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
  26. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October.
  27. Marc-André Letendre, 2004. "Capital utilization and habit formation in a small open economy model," Canadian Journal of Economics, Canadian Economics Association, vol. 37(3), pages 721-741, August.
  28. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report 280, Federal Reserve Bank of Minneapolis.
  29. A. Senhadji Semlali, 1997. "Sources of Debt Accumulation in a Small Open Economy," IMF Working Papers 97/146, International Monetary Fund.
  30. Black, Fischer, 1990. "Mean Reversion and Consumption Smoothing," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 107-14.
  31. King, Robert G & Plosser, Charles I & Rebelo, Sergio T, 2002. "Production, Growth and Business Cycles: Technical Appendix," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 87-116, October.
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