El. Grinols et Sj. Turnovsky, EXCHANGE-RATE DETERMINATION AND ASSET PRICES IN A STOCHASTIC SMALL OPEN-ECONOMY, Journal of international economics, 36(1-2), 1994, pp. 75-97
This paper constructs a stochastic general equilibrium model of a smal
l open economy consisting of risk-averse optimizing agents. The stocha
stic processes describing the rate of monetary growth, government expe
nditure, private production, and the foreign price level are taken to
be exogenous, determining all asset risks and returns, and the equilib
rium stochastic process describing the domestic inflation rate and the
exchange rate. The model is used to examine the effects of the means
and variances of policy shocks on the equilibrium and the determinants
of the foreign exchange risk premium.