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Equity Returns and Business Cycles in Small Open Economies

Authors

  • MOHAMMAD R. JAHAN-PARVAR,

  • XUAN LIU,

  • PHILIP ROTHMAN


  • We would like to thank seminar participants at Duke University, UC Santa Cruz, UNC Chapel Hill, Oklahoma State University, FDIC, and the WEAI 2009 annual conference. We are grateful for comments from an anonymous referee and those from Eric Aldrich, Tim Bollerslev, Neville Francis, A. Ronald Gallant, C. Aspen Gorry, Lutz Hendricks, Michael Hutchison, Joshua Izenman, Bruce Mizrach, George Tauchen, and Michael Salemi.

Abstract

This is the first paper in the dynamic stochastic general equilibrium literature to match key business cycle moments and long-run equity returns in a small open economy with production. These results are achieved by introducing four modifications to a standard real business cycle model: (i) borrowing and lending costs are imposed to increase the volatility of the marginal rate of substitution over time, (ii) capital adjustment costs are assumed to make equity returns more volatile, (iii) GHH preferences are employed to smooth consumption, and (iv) a working capital constraint to generate countercyclical trade balances. Our results are based on data from Argentina, Brazil, and Chile.

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