The equity premium in a small open economy and an application to Israel

Eliezer Borenstein () and David Elkayam ()

Economic Modelling, 2014, vol. 43, issue C, 81-99

Abstract: We show that the preferences suggested by Greenwood, Hercowitz and Huffman (GHH), which are quite common in real business cycle (RBC) models of small open economies, are not suited for reproducing both the business cycle and the equity premium facts of a small open economy. We show that by assuming a moderate degree of a wealth effect on labor supply, together with some limitations on labor supply (in the form of real wage rigidity), we can increase the volatility of the stochastic discount factor (SDF), thereby increasing the equity premium and improving the fit of the business cycle moments. We also find that under the aforementioned assumptions, a shock to the realized return on foreign bonds can help in reproducing the equity premium.

Keywords: Asset pricing; Equity premium; Real business cycle; Small open economy; Stochastic discount factor; Labor supply (search for similar items in EconPapers)
JEL-codes: E32 E44 F41 G12 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: The equity premium in a small open economy, and an application to Israel (2013)
Working Paper: The equity premium in a small open economy, and an application to Israel (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:43:y:2014:i:c:p:81-99

DOI: 10.1016/j.econmod.2014.07.047

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