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

Transcription

1 MPRA Mun Personal RePE Arve Te uy premum n a small open eonomy and an applaon o Israel Elezer Borensen and Davd Elkayam Bank o Israel. January 3 Onlne a p://mpra.ub.un-muenen.de/4399/ MPRA Paper No posed 3. January 3 4:7 T

2 Resear Deparmen Bank o Israel Te uy premum n a small open eonomy and an applaon o Israel Elezer Borensen* and Davd Elkayam** Dsusson Paper No. 3.3 January 3 Resear Deparmen Bank o Israel; p:// * Elezer Borensen E-mal: elezer.borensen@bo.org.l Pone: ** Davd Elkayam E-mal: davd.elkayam@bo.org.l Pone: We would lke o ank Pro. Zv erowz rom Tel-Avv nversy or very elpul ommens on an earler verson. We ank also e parpans o e semnar o e Bank o Israel Resear Deparmen. Any vews expressed n e Dsusson Paper Seres are ose o e auors and do no neessarly rele ose o e Bank o Israel חטיבת המחקר בנק ישראל ת"ד 78 ירושלים 97 Resear Deparmen Bank o Israel POB Jerusalem Israel

3 Te uy premum n a small open eonomy and an applaon o Israel Elezer Borensen and Davd Elkayam Absra In s paper we aemp o reprodue bo e busness yle as and e uy premum o e Israel eonomy an eonomy w s "ypal" n e sense a nvesmen s mu more volale an oupu and onsumpon. We sow a G preerenes w are que ommon n RB models o small open eonomes are no sued or reprodung bo e busness yle and e uy premum as o a "ypal" small open eonomy. We ound a a way o progress s o "orre" e G preerenes by addng some degree o weal ee on labor supply. Ta s by swng o e Jamov-Rebelo 6 ype o preerenes. owever n s ase we also need o add o e model some knd o lmaons on labor supply we used bo real wage rgdy and abs n labor. Our man ndng s a e use o Jamov-Rebelo preerenes onsderably mproves e resuls relave o a aeved by G preerenes. Te reason or s s a e G preerenes are araerzed by a relavely g degree o subsuably beween onsumpon and lesure and s moderaes e volaly o e soas dsoun aor SDF. By addng some degree o weal ee we an aeve a sgnan nrease n e volaly o e SDF and ene an nrease n e uy premum and n e volaly o nvesmen. Followng e relevan leraure we used ree soks: o produvy o governmen expendure and o e world neres rae. Our analyss suggess a by addng one or more o wo knds o soks: soks o weal and soks o e real exange rae one an aeve a sgnan progress n reprodung bo e busness yle as and e uy premum.

4 פרמיית המניות במשק קטן ופתוח ויישום למשק הישראלי דוד אלקיים ואליעזר בורנשטיין תקציר בנייר זה אנו מנסים לשחזר את מאפייני מחזור העסקים הריאלי בד בבד עם פרמיית המניות במשק הישראלי משק שהנו "טיפוסי" במובן זה שההשקעות בו תנודתיות בהרבה מן התוצר ומן הצריכה. אנו מראים כי פונקצית התועלת מסוג G אשר הינה מקובלת למדי בניתוח מחזורי עסקים ריאליים RB למשקים קטנים ופתוחים אינה מתאימה לשחזור של מאפייני מחזור העסקים יחד עם פרמיית המניות במשק קטן ופתוח סטנדרטי. מצאנו כי ניתן לשפר את התוצאות באמצעות "תיקון" פונקצית התועלת בכיוון הוספת מידה מסוימת של השפעת רכוש על היצע העבודה זאת באמצעות מעבר לפונקצית התועלת של 6.Jamov-Rebelo עם זאת במקרה זה עלינו להוסיף למודל גם מגבלות מסוימות על היצע העבודה הוספנו הנחה של קשיחות של השכר הריאלי וקיום הרגלים בהיצע העבודה. הממצא העיקרי שלנו הוא כי השימוש בפונקצית התועלת של Jamov-Rebelo משפר באופן משמעותי את התוצאות ביחס לאלו המושגות תחת העדפות.G הסיבה לכך היא שהעדפות G מאופיינות במידה גבוהה יחסית של תחליפיות בין הצריכה לפנאי ולכך יש השפעה ממתנת על התנודתיות של מקדם ההיוון הסטוכסטי.SDF על ידי הוספת מידה מסוימת של השפעת רכוש על היצע העבודה ובתוספת עם מגבלות על יכולת ההתאמה של היצע העבודה מתקבלת עלייה ניכרת בתנודתיות של ה SDF ובעקבותיה עלייה בפרמיית המניות ובתנודתיות של ההשקעות. בעקבות הספרות הרלוונטית השתמשנו בשלושה זעזועים: לפריון להוצאה הממשלתית ולשער הריבית העולמי. הניתוח שלנו מצביע על כך שעל ידי הוספת אחד או יותר משני סוגי זעזועים: זעזועי רכוש וזעזוע לשער החליפין הריאלי ניתן להשיג שיפור ניכר ביכולת לשחזר את מאפייני מחזור העסקים יחד עם פרמיית המניות.

5 . Inroduon A well known resul n e busness yle asse prng leraure s a e sandard real busness yle RB model s unable o reprodue e uy premum observed n e daa. In order o be able o produe a reasonable uy premum ere mus be some real rons n e real busness yle model w make dul or e onsumer o ully and reely smoo margnal uly o onsumpon n response o exernal soks. 3 Abel 99 and onsanndes 99 ave sown a g rsk averson and g degree o ab ormaon n onsumpon an generae an uy premum n an endowmen eonomy. Jermann 998 exended e resuls o a produon eonomy w endogenous apal bu w onsan labor npu. Te ably o e onsumer-produer o reely adjus nvesmen-savngs n response o exernal soks enables e onsumer o smoo e margnal uly o onsumpon. In order o produe an uy premum n s se up Jermann added apal adjusmen oss o e produon proess o apal. Te ger ose adjusmen oss are e arder s or e represenave onsumer-produer o adjus nvesmen-savngs n response o exernal produvy soks. Wen one allows labor npu o beome endogenous n Jermanns sandard RB model e uy premum usually dsappears. Te reason s a e onsumer an adjus labor supply n response o a produvy sok and so o onnue smoong margnal uly o onsumpon. Endogenous labor supply and e exsene o a relavely g weal ee on labor supply n e ommonly used preerenes n real busness yle models oen ause a ounerylal beavor o ours worked n e model wle n e daa labor npu end o be pro-ylal. Ts ouome oen ound n e models s e resul o a posve weal ee on labor supply. A negave produvy sok redues nome and onsumpon. Te onsumer would lke o ompensae or s o smoo margnal uly o onsumpon by workng more ours nrease labor supply. Te resul s oen a small or even negave orrelaon beween oupu and onsumpon and ours worked wle n e daa s orrelaon s usually gly posve. lg 6 7 suggesed overomng e above wo problems ounerylal labor npu and small uy premum by addng e assumpon o real wage rgdy o e model. By "sandard" we mean a ronless one agen omogenous model su as e one presened by Kng Plosser and Rebelo. For a survey see or example orane. 3 As s already known or example Leau and lg and wll be dsussed below e sape o e uly unon also as an mporan role n produng an uy premum. 3

6 In s se up e labor marke s always n a suaon o exess supply and e quany o labor s deermned by e demand o rms. A posve produvy sok nreases e demand or labor and e s o e le n e labor supply weal ee s no oo srong en labor wll onnue o grow w oupu. Ta means a n su a suaon e onsumer does no ave an ee on e quany o labor s deermned by demand only. In s se up lg sowed a a szeable uy premum an emerge n an oerwse sandard RB model. 4 Te aoremenoned leraure deal w losed eonomy models. Wen one moves o an open eonomy su as e model o Mendoza 99 and Sm-Groe and rbe 3 anoer degree o reedom s added: onsumers an adjus er exernal borrowng poson. In order o produe an uy premum n su a se up Parvar e al. added o e model adjusmen oss or adjusng e exernal deb poson o e onsumer. Tey appled e model o e daa o ree Sou Ameran ounres Brazl Argenna and le and sueeded n mang bo e busness yle as and e uy premum o ose ounres. To e bes o our and er knowledge s s e only paper a res o ma busness yle momens and uy premum n a small open eonomy. Parvar e al. used a model w G 5 preerenes a s que ommon n models o small open eonomes. An mporan araers o ese preerenes s e absene o a weal ae on labor supply. Ts elps o reprodue e busness yle momens o an open eonomy wou e need o "add" real wage rgdy. owever e busness yle as o e above menoned ounres der a leas w one respe rom e daa o a ypal small open eonomy. As an be seen n Table 3 o Parvar e al. n e above menoned Sou Ameran ounres and n e spe me perod o er resear 6 e volaly o nvesmen s que smlar o a o onsumpon. 7 On e oer and n our daa as well as n mos small open eonomes 8 e sandard devaon o nvesmen s sgnanly larger 4 We an name a leas wo oer ways o overome e above wo problems aused by endogenous labor supply n a represenave agen model. Boldrn rsano and Fser added ron o e labor marke by speyng lmed seoral mobly. Jaard added o e model nernal ab ormaon n labor. 5 Ts unon was rs proposed by Greenwood erowz uman Ter resear overs e perod 993 o 7. 7 Te sandard devaon o nvesmen and onsumpon s 5.56 and 4.73 peren respevely n Argenna. In Brazl e numbers are 9.9 and 8.66 respevely and n le.8 and 6.8. In Israel e gures are.3 and. respevely. 8 For example: anada Porugal Fnland Norway Porugal and Belgum. In ese ounres e volaly o nvesmens s more an 3 mes e volaly o onsumpon. 4

7 an a o onsumpon 9. As wll be dsussed laer n s paper seems a e G uly used by Parvar e al. s no sued o reprodue bo e busness yle and e uy premum as o a "ypal" small open eonomy. In s paper we are ryng o reprodue bo e busness yle as and e uy premum o e Israel eonomy w s ypal n e sense a nvesmen s mu more volale an oupu and onsumpon. Followng Parvar e al. we sared w e G uly. sng s unon we ound dul o reprodue bo e busness yle as and e uy premum o our daa w are que smlar o a ypal small open eonomy. We ound a a way o progress s o "orre" e G preerenes by addng some degree o weal ee on labor supply. We do s as wll be explaned laer by swng o e Jamov-Rebelo 6 ype o preerenes. owever n s ase we also need o add o e model some knd o lmaons on labor supply we used bo real wage rgdy o e knd proposed by lg 6 7 and abs n labor. As we sall see laer e addon o some degree o weal ee and wage rgdy an mprove e even wen we look only on e busness yle momens.e. gnorng e uy premum. Our man ndng n s paper s a e use o Jamov-Rebelo eneor JR preerenes onsderably mproves e resuls relave o a aeved by G preerenes. Te reason or s as wll be dealed laer s a e G preerenes are araerzed by a relavely g degree o subsuably beween onsumpon and lesure and s moderaes e volaly o e soas dsoun aor SDF. By addng some degree o weal ee we an ge a sgnan nrease n e volaly o e SDF and ene an nrease n e uy premum and n e volaly o nvesmen. An nuve explanaon s as ollows. Assume a negave enology sok w redues onsumpon and us nreases e margnal uly o onsumpon and redues e demand or labor. In bo G and JR preerenes onsumpon and lesure are subsuable. In e G ase e weal ee on labor supply s zero a s e delne n labor moderaes o a large degree e nrease n e margnal uly o onsumpon su a e onsumer s no neresed n nreasng labor supply. In e ase o JR preerenes e weal ee s posve a s e onsumer wses o nrease labor supply n order o moderae e nrease n e margnal uly o onsumpon. Bu beause o e exsene o wage rgdy e s prevened rom dong so reely and s generaes nreased volaly o e margnal uly o onsumpon relave o e ase o G. 9 In a even or e above menoned Sou Ameran ounres we look a a longer perod en a used by Parvar e al. we see mu more regular beavor o e busness yle momens. 5

8 In e model we used ree soks: o produvy o governmen expendure and o e world neres rae. An neresng ndng o s paper s a addonal soks mg make large onrbuons o e uy premum. As wll be dealed laer s may nlude soks o weal and soks o e real exange rae. In e nex seon we presen e model. In seon 3 we presen and dsuss e daa and n seon 4 we dsuss e albraon o e parameers. In seon 5 we revew n bre e relevan asse prng uaons. In seon 6 we presen and dsuss e resuls and seon 7 onludes. Mos o e enal aspes o e paper are le o e appendx.. Te model. ouseolds Followng e relevan leraure we assume a small open eonomy w nne number o denal ouseolds. Te represenave ouseold as e ollowng momenary uly unon: Were: and represen onsumpon and labor npu o e represenave ouseold. We assume e exsene o exernal ab ormaon bo n onsumpon and n labor npu. and represen aggregae onsumpon and aggregae labor npu and < < and < < are parameers represenng e degree o ab n onsumpon and n labor npu. In ea perod e represenave ouseold aes a budge onsran a s represened by e ollowng wo uaons: k [ o W K I Φ K K Γ [ TB Θ D D 3 D R D TB Te le and sde o uaon represens ouseold urren nome w s e sum o labor nome and apal nome were W and k represen e wage rae and e renal rae o apal. Te rg and sde o e uaon represens e uses o a nome: onsumpon nvesmen n pysal apal I lump sum axes Γ nvesmen abroad e rade balane TB and wo speal omponens: a os o adjusng apal Φ K K and a os o adjusng oregn asses Θ D Do. K and D are e apal In e speaon o e model we ollow rbe and Sm-Groe 3. 6

9 sok and e oregn deb a e end o perod e begnnng o perod and Φ. and Θ. are onave os unons. Equaon 3 represens e evoluon o oregn deb were R s e world gross neres rae a perod w s deermned a e end o. We assume a R s exogenous and soas. Equaon 4 desrbes e evoluon o e apal sok were δ s depreaon rae. 4 K δ K I We subsue TB and I rom 3 and 4 no. ouseolds oose a proess { Y I K D} a maxmzes leme expeed uly: E β Subje o uaon were <β< s e rae o me preerene. Le Λ be e Lagrange mulpler on uaon. Te rs order ondons o e maxmzaon problem are uaons o 4 above and 5 o 8 aead: 5 Λ βr Θ D E Λ D D 6 Λ 7 Λ W 8 Λ β E R [ Λ Were: R s e gross reurn on nvesng n apal sok and s gven by: 9 R k δ Φ k K Φ K K k K Te above rs order ondons uaons 5 o 8 are que sandard. Equaon 6 e rs order ondon w respe o onsumpon denes e sadow value o weal Λ n erms o onsumpon. Equaon 7 s e rs order ondon w respe o supply o labor. Equaon 5 and 8 are e prng uaons or oregn bonds and soks. Te maxmzaon s also subjeed o a no-ponz onsran w respe o D. For ease o exposon we rea e uly unon as me separable. In s ase e dervave o leme uly s ual o a o e momenary uly. Ts s rue or G or KPR preerenes see nex seon. For me non-separable preerenes one sould replae n 6 by e dervave o leme uly w respe o. 7

10 Ta s e ner-emporal Euler uaons a desrbe e ondons a e reurns on bonds and soks need o sasy.. Frms We assume an nne number o denal ompeve rms. Tey are owned by ouseolds and produe a nal good a s a pere subsue o e oregn produed nal good. Te represenave rm res labor serves and rens apal sok rom ouseolds o produe oupu Y aordng o a obb-douglas produon unon: Were α α A F K A K Y A s e enology level. In ea perod e rm ooses and K o maxmze s pros: A K α k K Te rs order ondons are: W α W A F K A α α k K α Y A Fk K Aα α K K Y.3 Te drvng ores Governmen onsumpon G s assumed exogenous soas nonproduve and naned by lump-sum axes. Ta s: 3 G Γ For e exogenous varables we assume e ollowng AR proess: 4 5 ln G ln R g g lng ρ ln G ρ ε ln R ρ ln R g ρ ε r a 6 ln A ρ ln A ε Were G and R are seady sae values. Te nnovaons ε ε ε are assumed o be..d varables w varanes σ g σ r σ and are also no orrelaed w ea oer. For e os unons Φ K K andθ D Do we assume e ollowng speaon: g r 7 Φ k K K.5φ K K 8

11 9 8.5 Θ d o D D D D φ To solve e model we need o spey an expl uly unon. Te soluon s a se o soas proesses o e endogenous varables Γ } { k W D K I Y and o e drvng ores } { A R G sasyng uaons -6 gven uaons 7-8 and e nal ondons or D K and or e soks g ε r ε ε..4 Te uly unon For e uly unon we sall use e speaon a was suggesed by Jamov- Rebelo 6: } [ { Were and are urvaure parameers 3 and s a sale parameer. Te parameer governs e magnude o e weal elasy o labor supply. As delnes e negave nome ee on labor supply delnes n absolue value. In e polar ase o e unon ges e orm o G uly w as e orm: a [ [ One o e araerss o a unon s a labor supply depends only on e real wage and s ndependen o e margnal uly o nome e nome elasy o labor supply s null. In e oer polar ase wen e unon ges e orm o KPR 4 uly: b } [ { Several papers ave sown a a G uly unon s more sued an e KPR unon o reprodue e busness yles as o a small open eonomy. 5 As we sall see 3 In e absene o onsumpon abs s e oeen o relave rsk averson and n e absene o labor abs s e nverse o e Frs elasy o labor supply. 4 Aer Kng Plosser Rebelo orrea e al. 995 rbe and Groe 3.

12 laer by nreasng rom o abou.5 we an do beer relave o G and KPR ules n reprodung e busness yle as o e Israel eonomy. Reenly Parvar e al. used a model w G preerenes and suessully reprodued bo e busness yles as and e uy premum o several Sou Ameran ounres. owever e busness yle properes o ose ounres der n several respes rom our daa. 6 As an be seen n Table 3 o Parvar e al. n e Sou Ameran ounres o w e paper reers and durng e spe perod under sudy e volaly o nvesmen s smlar o a o oupu. 7 On e oer and n our daa as well as n many small open eonomes e sandard devaon o nvesmen s mu larger an a o oupu and onsumpon. We sall reer o s ssue laer on and lam a s no possble o reprodue bo e busness yle as and e uy premum o our daa w a G uly. For a purpose we sall ave o add some weal ee by usng e Jamov- Rebelo ype o uly a s nreasng above zero..5 Addng real wage rgdy Prelmnary smulaons w Jamov-Rebelo preerenes w a posve weal ee posve produed a mu lower orrelaon beween oupu y and labor an n e daa. Ts s a well known problem w s knd o uly unon. To overome s problem and o be able o produe an uy premum as wll be dealed laer we ollowed lg 6 9 and added e assumpon a e real wage s rgd. More speally we replaed e labor supply uaon 7 w e ollowng wo uaons: 7 Λ W 3 7 W W W µ µ Were W sands or e ronless real wage and µ s e degree o real wage rgdy. As as been sown by lg 6 9 and wll be also demonsraed below real wage rgdy an be an mporan soure o e uy premum. 6 Parvar e al used quarerly daa or e years 996 o 7. We used yearly daa or e perod 96 o 8. 7 See oonoes 7 and 8.

13 3. Asse prng 3. Te uy premum and e Sarpe rao In s seon we presen e asse prng uaons a were used o alulae e uy premum and e Sarpe rao 8. Le x ln be normally dsrbued en: 4 ln E E ln.5 varln E x.5 var x Te F.O. or apal uaon 8 above an be wren as: 5 M R E Were: R s e gross reurn on uy apal and M s e S.D.F a s: M βλ Λ. Takng logarms and assumng a R and M are log-normally dsrbued we oban aer a lle b o algebra usng uaons 4 and 5: 7 ln E R ln E M ov r m were: ar m E[ m E m e. For a rsk ree asse e reurn a me prng uaon 7 and usng e a a R s known a me. sng s n e ar Andov r m we ge e prng uaon or a rsk ree asse: r 8 r ln E M From 7 and 8 we ge e ollowng ondon or e uy rsk premum: 9 EP ln E R r ov r m βλ Now observe a: m ln lnβ λ λ lnβ λ Λ sng s n 8 we ave: 3 r lnβ E λ.5ar λ Noe also a: ar λ E λ E λ E λ E λ ar λ E λ λ E λ λ 8 Te maeral o s seon s based on lg 6. For more dealed dervaon see e appendx.

14 sng s n 9 we ge: 3 EP ln E ρ r R λ and e Sarpe rao s r σ r ov r σ λ λ ov r EP ov r λ 3 SR ρ r λ σ λ σ R σ R To ease e alulaon o e EP and SR rom e ouomes o a log-lnearzed DSGE model noe a or ea varable : ar ln ar ln ln e. were: s e seady sae value o. λ 3. Te uy premum and e Sarpe rao n erms o e elases o e margnal uly Log lnearzaon o e F.O. 6 above yelds: 336 λ η η were: η and η Subsue λ rom 33 n 3 we ge: 353 EP η ov r η ρ r σ r η σ ov r η ρ r σ r σ For e uy premum; And or e Sarpe rao we ave 363 SR η ρ r σ η ρ r σ. In appendx A.4 we presen e dealed alulaon o η andη or e ase o JR G and KPR preerenes.

15 4. Te daa For e albraon and or e empral momens we used e ollowng daa: Naonal Aouns We use yearly daa or e perod 96 o 8 on gross domes produ Y prvae onsumpon exludng durables 9 gross domes nvesmens I governmen onsumpon exludng dre deense mpors G and rade balane TB o oupu rao TBY. All seres are n erms o xed pres and per apa. For e analyss we expressed e varables n erms o perenage devaons rom P rend. Wages and Labor For labor we used e number o oal employees per apa mulpled by e average workng ours per employee.e. oal ours worked per apa. For wage we used e averaged monly wage per employee pos delaed by e PI. Bo seres are expressed n erms o perenage devaons rom an P rend. Grap presens e beavor o e man omponens o e naonal aouns varables durng e perod 96 o 8. As an be seen onsumpons volaly s que smlar o GDPs volaly wereas Invesmens volaly s mu ger. Anoer noeable a s e g posve orrelaon beween Labor and GDP a s labor s pro-ylal. 9 We also eked e seres o oal prvae onsumpon and repor s sass n e relevan ables. Te rade balane TB was alulaed as e derene beween e GDP and e sum o e ree uses: prvae onsumpon governmen onsumpon and gross domes nvesmens 3

16 Grap : Beavor o man Naonal Aouns daa durng 96 o LOGY P_TREND _RES Y_RES G_RES Y_RES I_RES Y_RES TB_S_RES Y_RES _RES Y_RES 4

17 Fnanal Daa For e oregn rsk ree rae we used monly daa or on e nomnal yeld o maury on one-year S Treasury blls. We subraed aual annual nlaon.e. n e las welve mons rom e nomnal yeld and en e daa were yearly averaged. For e domes rsk ree asse we used daa or on e yeld o maury on one-year Israel governmen PI ndexed bonds. For e domes soks we used monly daa or 97 on e real oal reurn on soks. As anoer alernave o e oldng o a rsk ree asse we also used daa on e real oal reurn on e wole porolo o governmen ndexed bonds or 976. Table summarzes e man asse prng as or e Israel eonomy durng e years 97 o. Durng a perod e average yearly real reurn on soks was.73 peren wle e real reurn on one year governmens bonds was 3.34 peren. Ta s we observe an average uy premum o 9.39 peren per year w s que n lne w wa s observed n oer ounres. We sould also noe e very g volaly o e yearly rae o reurn on soks 35.6 peren w s by ar larger an a observed n oer ounres. Noe a e uy premum s que sable durng mos o e perod n - seemed o delne due o a delne n soks reurn. Due o e very large volaly o soks reurn e Sarpe rao SR s relavely low abou.6 ompared o a gure o abou.5 n S. Grap presens e value o e wo ollowng porolos: Te rs represened by e lower lne s omposed o governmen ndexed bonds. Te seond represened by e upper lne s omposed o soks. Bo porolos were saled o n 976 e begnnng o our rsk ree bond daa. As s lear rom e grap e value o e sok porolo s mu more volale an e bond porolo and s grow was mu ger wle e "rsk ree" porolos value grew by 6% e value o e sok porolo grew by more an %. Ts grap oers a good vsual presenaon o e bas rsk-reurn radeo: or ger reurns one as o bear ger rsks. onsrued rom varous soures. 5

18 Table Real reurn on soks and bonds n e Israel eonomy 97 Equy oal reurn Perod Mean Sandard devaon Yeld o maury o a -year ndexed governmen bond Mean Sandard devaon Toal real reurn on a porolo o ndexed bonds Mean Sandard devaon Grap : Asse prng as o e Israel eonomy Rsk ree bond Soks 6

19 5. albraon We rs reer o e albraon o e model under e G preerenes. Laer we wll presen e anges made under Jamov-Rebelo preerenes. We need o albrae e ollowng ls o parameers: { r g β α δ R ρ ρ σ r σ g g s s b k d ρ σ φ θ µ } In dong so we ollowed a smlar sraegy o a o Parvar e al.. We dvded e parameers o e model no ree groups. Te rs group onans e parameers o e uly unon: { β }. We do no ave a srong a pror knowledge o e values o e urvaures and and on e abs parameers and. We sared w values a are ommon n e relevan leraure and perormed sensvy eks. Tus or e urvaure parameer on onsumpon we used ree values: and 5 and evenually we ose 5. For e urvaure on employmen we eked several values n e range o.5- and we ose.9 evenually n order o ge e volaly o labor lose o e daa. For e ab n onsumpon and n labor we red.4 and.6 and evenually we ose.6 or bo. Te labor parameer was osen su a e seady sae value o labor s e same as n Sm-Groe and rbe 3 3 noe a depends also on e abs oeens. β s se o ulll e seady sae relaon: β R. Te seond group nludes parameers a we albraed usng soral daa. Ts group r g onans: {α δ R ρ ρ σ r σ g s g s b µ }. α e sare o labor n naonal nome s se a.67 based on Naonal Aouns r daa. To esmae parameers o e world neres rae ρ σ we used yearly daa or e years 954 o 9 on e real yeld o maury on one-year S Treasury blls deals n appendx. Te esmaes are.695 and.37 or r ρ and r σ respevely. For e seady r In e absene o ab n labor s means a Frs elasy o.. 3 In er paper ey ave a seady sae value o.74 or labor. orrea e al. 995 appled e ollowng meodology o albrae e seady sae value o : ey assumed a ere are poenal workng ours n a week and a average work week s 4 ours. Mulplyng s by e employmen rae yelds a value or e seady sae o. In Israel e sample average o e employmen rae s.56. So applyng s meodology o Israel yelds:.56 * 4 / owever usng s value aused us problems n e soluon o e model wen e rsk averson and ab parameers ook g values. Tereore we deded o say w e Sm-Groe and rbe albraon. 7

20 sae rsk ree rae R we used e sample mean o real yeld o maury on a one-year Israel governmen bond We se: δ. w s que lose o wa s derved rom e sample mean o e rao o nvesmen o oupu. 5 Te parameers g ρ and σ were esmaed usng an auo-regresson o e.p. lered g devaons o governmen onsumpon or e perod 98 o 8. 6 To esmae s g e governmen onsumpon sare n oupu we used e sample or a perod. 7 For s e rade balane sare o oupu we used e sample mean n e perod 96 o b 8 and go value o As or e parameer µ wage rgdy we rs red o esmae by a regresson based on daa o real wage onsumpon and employmen all n erms o devaons rom.p rend. Te log lnearzed verson o uaons and s 9 : 39 7 w η η η η 47 w µ w µ w Pluggng w rom 39 no 4 we ge: 4 w µ η η µ η η µ w 4 Anoer possbly s o use e mean o e sample n erms o.s daa w appens o be.7. We preer o base e esmae o R on Israel daa. Te derene an be nerpreed as a "onsan" rsk premum. 5 In seady sae gnorng grow we ave: I. Y R αδ δ. 33 * In e daa nvesmen nludes durables onsumpon goods e average nvesmen oupu rao s.46 wou durables goods e rao s.5. 6 We sorened e perod beause o major ange a ook plae n e proess or governmen onsumpon. 7 Te value n e daa was.3. We used a value a b lower.8 sne perormed beer n e model soluon due o numeral ssues. 8 Sne we also waned o albrae e deb o GDP rao o be smlar o e daa around. we slgly moded. 3 su a e deb evolvemen s deermned by e urren aoun and no e rade balane by sel. Te rao o urren aoun o GDP was albraed su a e seady sae value o deb o GDP wll ual.. 9 For e G 39 akes e orm: w and or e KPR we ave: Z Z w were Z [ or deals see appendx A4. 8

21 sng e albraed values or n 4 we an esmae µ n 4. We esmaed 4 by OLS and by SLS 3 ; n bo ases e esmaes were lose o.76. For e albraon we used a slgly ger value.85. Parameer Table : albraed and esmaed parameers Fnal value R Sensvy r g Parameer α δ R ρ ρ σ r σ g s g s µ b alue k d Te rd group onans ve parameers {ρ σ φ θ }. To nd e value o ose parameers we ondued a grd sear on e rs our or varous values o as wll be dealed n e nex seon. In e grd sear we red o ma e ollowng en momens: sandard devaon o oupu σ sandard devaon o onsumpon σ y sandard devaon o nvesmens σ sandard devaon o labor npu σ sandard devaon o rade-balane o oupu rao σ rs order auo-orrelaon o oupu ρ labor-oupu orrelaon y ρ nvesmen-oupu orrelaon y ρ rade-balane y y o oupu rao-oupu orrelaon ρ and mean uy premum EP. Speally we by y seared or e parameers a mnmze a loss unon omposed o e square dsane beween e smulaed momens and e momens n e daa. 3 We ondued e grd sear under wo alernaves. In e rs alernave we looked only a e busness yle aspe o e model. Ta s we exluded e uy premum rom e loss unon. In e seond alernave alernave we added e uy premum o e loss w a weg o.5.e. we assgned a 5 peren weg o e real busness yle momens and a 5 peren weg o e uy premum. Te albraed values o e rs by and e seond group o parameers are lsed n Table. β 3 We used e ollowng nsrumens: w w3 3 3 or e perod For deals see appendx A.6. 9

22 6. Resuls In e rs subseon we wll presen e man resuls. In e seond we sall expand on e explanaons. In e rd subseon we sall reer o e role o e governmen expendure sok and o e poenal role o oer weal soks. In e our subseon we sall reer o e poenal role o sok o e real exange rae. 6. Man resuls In Table 3 we presen e resuls obaned under varous values o beween and. In e rs olumn o Table 3 we presen e relevan momens o e Israel daa. Apar rom e rs olumn e able onans our addonal bloks and ea blok onans wo olumns. In e rs olumn o ea blok labeled "No EP" we presen e resuls obaned wen we onsder only e busness yle aspe o e daa.e. gnorng e rsk premum n e loss unon; we also reer o a alernave as "alernave ". In e seond olumn o ea blok labeled "EP" we presen e resuls wen e uy premum s added o e loss unon we also reer o a alernave as "alernave ". Te las wo rows o ea olumn n bloks o 4 n Table 3 onan e value o e loss unon alulaed w e relevan parameers. Te rs row labeled "No EP" presens e loss wen e uy premum s absen rom e loss unon. Te seond row labeled "EP" presens e loss wen e uy premum s nluded n e loss unon. In ea olumn we presen also e k d opmum values o e our "seared by grd" parameers φ θ ρ σ. In blok we presen e resuls under G preerenes a s under. Lookng a e rs olumn o blok we an see a mos o e momens are que lose o e daa. Ts s no surprsng sne G preerenes are known o provde suessul replaon o e busness yle momens o a "ypal" small open eonomy. 3 Te uy premum under s alernave s. Wen we move o alernave a s we add a 9 peren uy premum o e loss unon w a weg o 5 peren we aeve a large lose o daa uy premum 8.87 bu e busness yle "" s worsened onsderably. 33 Te value o e loss unon n s ase s.35. As an be seen n order o aeve a large uy premum k φ and d φ mus nrease onsderably. Te "pre" s a large reduon n e 3 orrea e al. 995 and rbe-groe Te value o e loss unon o alernave w e seared by grd parameers o alernave s.69 ompared o a value o.5 aeved w e parameers o alernave a s s 4 mes bgger.

23 sandard devaons o and o b / y. Te sandard devaon o nvesmen redued o 3.6 rom a value o.6 under alernave were n e daa e relevan number s.3 and e sandard devaon o e rade balane o oupu rao delnes o.4 rom a value o.4 under alernave were n e daa e relevan number s.6. Ts s no a surprsng resul. In order o reprodue an uy premum n a sandard RB model we need o "add" sgnan real rgdes. A larger value o k φ means a larger os o adjusng e apal sok and s makes dul or e produer-onsumer o smoo e margnal uly o onsumpon n response o exernal soks. Smlarly a large value o d φ means a large os o adjusng e exernal borrowng poson or e produer-onsumer wen e res o smoo e margnal uly o onsumpon n response o soks. As wll be dealed below seems a s resul e large reduon o e sandard devaon o nvesmen s general n e sense a G preerenes are no so suable or replang bo e busness yle and e uy premum o a ypal small open eonomy. We ound a addng some weal ee o labor supply a s o nrease above zero elps subsanally n mang e daa. Blok presens e resuls wen. 5. Ts value yelded e lowes loss.733 under alernave. omparng e resuls o alernave n bloks and we see a nreasng rom o.5 enables us o aeve a smlar uy premum bu w a mu beer o e busness yle momens. We see an mprovemen n e sandard devaons o y and and n e rao o e sandard devaon o and relave o a o y. Noe also a e rao o e sandard devaon o o nreased rom abou.3 3.6/3. n blok o abou 3. 8./.6 n blok w s sll owever lower an e rao o 5.6.3/. n e daa. In e nex subseon we sall expand on e auses o s mprovemen. Wen we ompare e resuls o alernave n bloks and we see a e resuls under. 5 are beer an ose aeved usng e G preerenes e loss redued rom.5 o.75. Ta s a leas n our albraon even wen we onenrae only on e busness yle momens we an subsanally mprove e by nreasng. We an see an mprovemen n e sandard devaon o oupu onsumpon and nvesmens and n e rao beween em a s n e rao o e sandard devaon o onsumpon and nvesmen relave o a o nome. Noe also e mprovemen o e orrelaon o and w y. In bloks 3 and 4 we presen e resuls wen we ge loser o KPR preerenes

24 . 5 and. 99. As an be seen under bo alernaves ere s an nrease n e loss.e. e worsens e loser we are o e KPR preerenes. omparng e resuls o e G preerenes we see a wen. 99 a s we are very lose o KPR preerenes e loss under alernave s lower an n e G ase wereas under alernave s ger. I sould be noed a n all o e ases wen we sear or an uy premum σ e sandard devaon o e rsk ree neres rae s very g ompared o s sandard devaon n e daa.7%. Ts s known as e rsk ree rae volaly puzzle and s a eaure o many DSGE models. Parvar e al. lam a er model does no presen s problem sne e rsk ree rae aordng o em s pnned down by e worlds neres rae w s no very volale and ye e uy premum s g enoug beause e deb adjusmen oss ause e IMRS o beome volale enoug. In our vew e orre neres rae a sould be onsdered as e rsk ree rae and e one a sould be ompared o e daa s e one akng no aoun e adjusmen oss o borrowng and lendng rom abroad.e. e eeve rsk ree neres rae. Ts eeve rsk ree neres rae s e one we presen n our ables and s alulaed as ollows: r e R Θ D D D Wen dedng weer o nves n a loal bond or n a oregn bond e nvesor wll ake no aoun e adjusmen oss nurred by angng e oregn deb poson. Tereore a no-arbrage ondon wll uae e expeed reurn on e loal bond w r e e sandard devaon o e loal bond s.7%. Te sandard devaon o. r. In e daa e r wen.5 s mu ger 4%. Tus as an be seen we are no able o ge over e rsk ree rae volaly puzzle n any o e ases. Ts problem remans n e nex seons as well.

25 Table 3: Busness yle momens and e uy premum Israel daa and e model under e Jamov-Rebelo uly unon. Daa Israel No EP EP No EP EP No EP EP No EP EP Sandard devaons Y I Tb/y Seral orrelaons Y orrelaons w oupu I b/y Equy premum EP σ e r SR Parameer alues d θ E E5.357.E7.354.E k φ 6.7E E-.98.E E ρ σ Loss unon value No EP EP Table 3a presens a deomposon o e uy premum o s omponens. Te upper par o Table 3a "Toal" presens e deomposon o e uy premum under ea alernave aordng o uaon 35 n e ex. I sould be noed a η and η are no a unon o e parameers a we seared over bu ov r and ov r do depend on ose parameers. Te able ndaes several pons. Frs wen we ompare alernaves and n ea blok we see a ere s a derene n e ovarane o onsumpon and labor w e 3

26 reurn on uy. Te ger uy premum under e "EP" alernaves s aeved roug an nrease n e ovarane beween onsumpon and e reurn on uy. For example under alernave n e rs blok e uy premum s aeved by nreasng e ovarane beween onsumpon and e reurn on uy rom. n alernave o.76 n alernave. Seond e nrease n e ovarane beween onsumpon and e reurn on uy s aompaned by a large nrease also n e ovarane beween labor and e reurn on uy w as a negave onrbuon o e uy premum and s omponen moderaes e posve onrbuon o e ormer omponen. Trd wen movng rom. "G" o.5 bo η and η all. owever η alls relavely mu more anη and s elps o aeve e uy premum. We sall reurn o s pon soon wen we sall revew e soures o e beer resuls obaned under JR preerenes. Te res o e able presens e onrbuon o ea sok o e oal uy premum and o e ovaranes. I s lear a e bgges soure o e uy premum s e enology sok "eps" aounng or an uy premum o 7.67 peren ou o a oal value o 8.87 n e G ase or example. I s also lear a e sok o e world neres rae "epsrw" does no onrbue a all o e uy premum and o e ovaranes. Ts appens beause e ange n e world neres rae s no suen o generae a srong response o r sable. 34 w us says almos Te governmen sok "epsg" onrbues a small par o e uy premum. peren n e G ase. owever noe a s onrbuon. peren s assoaed w a very low ovarane o and r n e G ase:.3 peren as opposed o.76 o e enology sok and also w a very low ovarane o and r. Wen we nrease s ovarane even beomes negave w means a posve onrbuon o e uy premum. Ts suggess a large governmen soks and n general expendure or weal soks may ave a relavely srong ee on e uy premum. Ts pon wll be elaboraed n subseon d Ts ouome depends on e value oφ. I s small enoug e reaon o sronger us avng a bgger nluene on e uy premum and e ovarane. r ould be 4

27 Table 3a: Te uy premum and s soures under Jamov-Rebelo preerenes EP η ov r η ov r Toal No EP EP No EP EP No EP EP No EP EP ea_ ea_ ovr ovr Equy premum % eps ovr ovr Equy premum % epsrw ovr ovr Equy premum % epsg ovr ovr Equy premum % * Te soks onrbuons o e general uy premum don always add up exaly o % due o approxmaons. 5

28 6. Movng rom G o JR preerenes: e soures o mprovemen n e loss unon Table 4 elps n solang e soures o e mprovemen n e loss unon wen movng rom G preerenes o JR preerenes. olumn o Table 4 presens e resuls o e opmzaon n e ase o G wen lookng or an uy premum s e same as e EP alernave n e rs blok o Table 3. As noed earler e bgges drawbak o e resuls under e G preerenes s e very low absolue and relave sandard devaon o nvesmens 3.6% as opposed o.3% n e daa and a rao o.5 beween e sandard devaons o nvesmens and onsumpon as opposed o 5.6 n e daa. Wen movng o e JR preerenes under.5 olumn 4 n Table 4 we ge an mprovemen n e loss unon value - rom a loss o.35 under G preerenes o a value o.733 under.5. I seems a e mos noeable derene n e.5 ase s e sandard devaon o nvesmens w s ger bo n absolue value 8. peren and relave o e sandard devaon o onsumpon 3. also due o a small reduon n e sandard devaon o onsumpon. As we see e move o JR preerenes elps n rasng e absolue and relave sandard devaon o nvesmens wou avng o ompromse on e uy premum. Noe a one o e auses o e low sandard devaon o nvesmens under e G ase s e k k g level o apal adjusmen oss φ nder.5 φ s mu lower.98 w may explan par o e larger volaly o nvesmens. k To assess e onrbuon o e reduon n φ we perormed a smulaon under e k G preerenes usng e same parameer values o olumn exep oφ or w we used a value o.98 Te value ound opmal under.5. Te resuls w are presened n blok o Table 4 sow a e sandard devaon o nvesmens goes up a lle o 4.5 peren wle mldly lowerng e sandard devaon o onsumpon resulng n a small mprovemen o e relave volaly o nvesmens o onsumpons volaly k.5. ene e lower value oφ explans only a small par o e mprovemen n e loss unon value. Te uy premum n s ase delnes sarply o.39 peren. Blok 3 presens e resuls o runnng e smulaon w e same parameers o blok wle angng o.5. I an be seen a now we observe a mu beer relave volaly o 6

29 nvesmens Blok 4 presens agan e resuls o e opmal parameer values or.5 were e opmal ρ and σ were ound o be ger. Te relave volaly o nvesmens says e same bu e ger sandard devaon and perssene o e enology sok rases e absolue sandard devaons o all o e varables us geng e momens mu loser o ose n e daa. Table 4: Movng rom G o e Jamov-Rebelo uly unon: Te soures o mprovemen n e loss unon 3 4 Daa Israel Sandard devaons y b/y Seral orrelaons y orrelaons w oupu b/y Equy premum EP σ e r SR....4 Parameer alues d θ k φ ρ σ Loss unon value No EP EP Ts rao s very lose o e rao n mos o e small open eonomes weve examned see oonoe 8 or deals. 7

30 To undersand ow e move o JR preerenes elps n rasng e relave volaly o nvesmens s useul o examne e IRF o e model. Fgure presens e IRF o a negave enology sok w a sze o a one sandard devaon or seleed varables under e G preerenes n e red lne and under e JR preerenes wen.5 n e blue lne. Te parameer values used o alulae e presened IRF are e same as ose a were used o onsru e opmal resuls or e G uly unon Alernave n blok o Table 3. Ta s anges n e resuls or e.5 ase are only due o e ange n. Fgure IRF: A negave enology sok Le us look rs a e G ase e red lne. A negave enology sok lowers e rms demand or labor. I e labor supply o ouseolds doesn ange as n e G ase e lower demand resuls n a delne n e amoun o labor w ogeer w e delne n produvy auses a all n oupu y. Te lower oupu auses ouseolds 8

31 o redue bo onsumpon and nvesmen. 36 Te all n e demand or nvesmens ogeer w e all o produvy lowers e reurn on apal r. A e same me e delne n onsumpon auses e margnal uly o onsumpon λ o go up us ausng a negave orrelaon beween λ and premum. r w generaes a posve uy In e ase o JR preerenes e blue lne n response o e negave produvy sok ouseolds nrease er labor supply a weal ee and s moderaes e delne n labor and us also n oupu relave o e G ase. Ts resuls n a weaker all o onsumpon relave o e G ase. Invesmens owever all rougly e same as n e G ase 37 resulng n a que smlar all o e reurn on apal. In regard o e uy premum noe a e margnal uly o onsumpon λ nreases n e JR ase e same as n e G even oug e level o onsumpon alls less. Ts appens beause o e ger level o labor 38 bu also beause o e lower value o η 39 a as was noed earler alls relavely sronger an η. Sneλ and r rea abou e same as n e G ase e uy premum under bo ases s smlar. ene a small nrease o o.5 generaes a smlar uy premum w a mu ger volaly o nvesmens relave o onsumpon. 6.. Te role o wage rgdy In e ollowng we sall demonsrae a e role o e wage rgdy n reprodung e uy premum n e G ase s neglgble. On e oer and n e JR preerenes as a enral role. More speally wa maers s e neraon o e weal ee on labor supply and e lmaon on ree adjusmen o labor aused by wage rgdy w generaes e uy premum. 36 Te demand or nvesmens alls beause ouseolds don wan onsumpon o all oo mu and also beause e produvy o apal makes nvesmen less proable. 37 Ts s beause o wo oseng ees: ouseolds wan o onsume more n e JR ase and s sould make nvesmen all even urer an n e G ase. Ye a e same me sne e amoun o labor s ger n e JR ase e expeed margnal produvy o apal mpk s ger us makng nvesmens more desrable. As menoned e ne ouome o ese wo annels s lose o zero under e spe parameers used n s ase 38 W s by sel also a resul o e lower value o η. 39 Reall a λ η η so a a lower value o η makes λ ger. 9

32 To llumnae e role o e wage rgdy we plo e IRF o a negave enology sok or bo o e ases presened n Fgure ompared o e same ases wou wage rgdy µ. Te IRFs are presened n Fgures and 3. Fgure IRF: A negave enology sok G preerenes Lookng a Fgure a negave enology sok ndues a reduon n e demand or labor. nder G preerenes ere s no s o e labor supply urve 4 so e amoun o labor alls. Wen wages are rgd ey go down very slowly. Tus e all n e amoun o labor s sronger n e ase o e wage rgdy as s e all n onsumpon. owever despe e sronger all o onsumpon e margnal uly o onsumpon λ reas e same n e ase o e wage rgdy. Ts s e resul o e all n labor nrease n lesure and e srong subsuably o lesure and onsumpon n e G uly unon a s ouseolds are "ompensaed" or er lower onsumpon w more lesure. Sne e 4 Noe a s appens beause o wo oseng ores: ouseolds would wan o work more n order o preven onsumpon rom allng. Ye a e same me sne ey onsume less er uly o lesure s ger and ereore ey would lke o work less. In G preerenes ese wo ores exaly ose ea oer resulng n e labor supply sayng unanged. 3

33 margnal uly o onsumpon λ responds e same 4 e uy premum says ere e same. Fgure 3 IRF: A negave enology sok JR preerenes. 5 Lookng a Fgure 3 e negave enology sok ndues a reduon n e demand or labor as n e G ase. owever nder JR preerenes e subsuon ee beween onsumpon and lesure s no srong enoug o make ouseolds oose o onsume less and work less as n e G ase. ere ere s a weal ee on labor supply ouseolds would lke o nrease er labor supply n order o sablze er margnal uly o onsumpon. For s reason wen µ labor goes up. In e spe parameer values used ere onsumpon aually rses nally. Wenµ. 85 labor does no go up and ene onsumpon alls. Noe a demand or nvesmens alls more wen wages are rgd o preven onsumpon rom allng urer. Ts auses e reurn on uy o all sronger. Te all n onsumpon resulng rom e wage rgdy auses e margnal uly o onsumpon o rea sronger n s ase and ogeer w e sronger all n e reurn on uy e resul s a ger uy premum. In onras w e G ase were 4 Togeer w e a a reurn on uy responds e same w s also manly a resul o e smlar response o λ. 3

34 ouseolds labor supply dd no s o e rg n response o e sok n s ase does. Addng e ron o e adjusmen o wages prevens ouseolds rom nreasng er labor eor as ey would lke o. Ta s s e neraon o e weal ee o labor supply and e lmaon on e ree adjusmen o labor aused by e wage rgdy w generaes e nrease n e uy premum. 6.3 Te role o governmen demand soks n reprodung an uy premum In e ollowng subseon we sall demonsrae e relave eeny o e governmen expendure sok n reprodung e uy premum. Ts leads us o onlude a oer soks w smlar arbues o e governmen demand sok a are urrenly absen rom our model mg ave an mporan role n reprodung e uy premum. Tese eaures are lkely o be a resul o expendure or weal soks bo o w ave a domnan weal ee. Table 3a presens e onrbuon o ea o e soks o e oal uy premum and o e ovaranes. As was noed e governmen sok onrbues a relavely small par o e uy premum. peren n e G ase. owever e uy premum generaed by s sok s aompaned by a very low ovarane o and r n e G ase:.3 peren as opposed o a onrbuon o.76 peren o e enology sok. In a sense s means a e governmen sok s more "een" an e enology sok sne s able o produe a sgnan uy premum w only a small volaly o onsumpon. 4 Ts resul omes rom e a a e ovarane o and r s mu lower n e governmen sok an n e enology sok so a e seond erm n uaon 35 does no redue e uy premum as mu as n e enology sok and may even ave a posve onrbuon o e uy premum e ovarane o and r s negave. To see e derene n e ees o e governmen sok and e enology sok we presen n Fgure 4 e IRF o a one sandard devaon o a posve governmen sok w redues onsumpon n omparson o a one sandard devaon o a negave enology sok w redues onsumpon as well. Te parameers used or e IRF alulaon are e ones rom e G resuls w a slg derene or exposonal purposes e sandard devaon and e perssene o e enology sok were adjused 4 Noe a ov r ρ r σ r σ and rom e mpulses we an see a e low ovarane beween and r s prmarly due o low varane o. 3

35 su a bo soks would yeld a smlar IRF or e onsumpon. Ts albraon yelded a sandard devaon o. or e enology sok as opposed o a sandard devaon o. or e governmen sok. From Fgure 4 s lear a wle bo soks ave e same ee on onsumpon e governmen sok as a mu larger ee on e margnal uly o onsumpon λ. Ts s e resul o e derene n e reaon o : n e ase o enology sok e amoun o labor dereases beause o e reduon o rms labor demand wle n e ase o governmen sok ere s no ange n e demand or labor and ene s level does no all on mpa. Sne does no all ere s no mgaon o e ee o e all n onsumpon onλ. Sne λ rses a lo n e governmen sok ase ouseolds oose o redue nvesmens srongly n order o sablze e margnal uly o onsumpon so e demand or nvesmen alls arder and w also e reurn on uy. So or a gven response o onsumpon e governmen sok auses a mu bgger response o λ and o r w enlarges e uy premum. Aloug e onrbuon o e governmen sok n our smulaons presened n Table 3a s que low due o e relavely small sandard devaon o governmen soks n our daa e resuls sow a n e presene o larger governmen demand soks er role may be mporan n explanng e uy premum and e busness yle momens observed n e daa. 43 To demonsrae s we ondu a grd sear as n seon 6. w e derene a we assume a mu ger sandard devaon o e governmen sok mes ger an n e bas albraon. Te resuls are presened n Tables A.5 and A.5a n Appendx A.5. Table A.5 sows a e larger volaly o e governmen demand as a neglgble ee on e loss unon value n e G ase. In e JR ase owever e ee s subsanal. Lookng a e resuls w e opmal value o w s now ger.5 an be seen a e loss unon value dereased sgnanly o.87 as opposed o.733 n e bas ase. Noe a one o e auses o e mprovemen s e beer o e volaly o e rade balane o oupu. Ts s e ouome o e lower d value oφ w means a e eonomy s mu more open. In essene one governmen demand soks are domnan 44 ere s no need o lose e eonomy so mu n order o 43 For example Parvar e al. repor a very large sandard devaon o e governmen expendure n Argenna and Brazl.3 and.3 respevely. 44 To see e domnane o e governmen sok noe n able 5a er g onrbuon o e uy premum. 33

36 ma e uy premum and ene e dynams o e rade balane are mu loser o e daa. Te mu mproved o e model wen e sandard devaon o e governmen expendure sok s ger mg mply a oer soks w smlar arbues o e governmen demand sok a are urrenly absen rom our model ave an mporan role n realy. More speally soks wose domnan ee s a reduon n onsumpon and n e reurn on uy aompaned by an nrease n labor supply are good anddaes. Tese eaures are lkely o be a resul o expendure or weal soks a ave a domnan weal ee. Fgure 4 IRF: A posve governmen sok vs. a negave enology sok G preerenes 34

37 6.4 Te role o soks o e nernaonal neres rae n reprodung an uy premum As an be seen n Table 3a e onrbuon o e nernaonal neres rae o e uy premum s low. In s subseon we sall explan wy. 45 Also noe a a bas assumpon n our model as well as n oer sandard RB models o a small open eonomy s a e real exange rae s onsan. Ts assumpon s que a odds w realy. In realy e aual reurn on oregn bonds n domes erms s nluened by luuaons n e real exange rae. In subseon 6.4. we sall also sow a e presene o large real exange rae luuaons may ave an mporan onrbuon o e uy premum. To assess e low onrbuon o e uy premum o soks o e nernaonal neres rae we presen n Fgure 5 46 e IRF o s sok. A posve sok o e worlds neres rae as wo ees. Te rs ee o e sok s a makes lendng abroad more arave an nvesng n domes apal and ene sould redue e demand or nvesmen. owever n e presene o g adjusmen oss n angng e deb poson as s e ase ere ouseolds wll be averse o angng er deb poson n response o e sok. Tereore on mpa e demand or nvesmens does no ange and e reurn on uy says sable as well. A seond ee o e sok as o do w e ee on ouseolds nome: ouseolds n e eonomy are ne borrowers rom e res o e world 47 ; us a rse n e worlds neres rae means a ouseolds ave o pay more on er deb and us ey redue onsumpon. In sum aloug n response o e sok e margnal uly o onsumpon goes up e reurn on uy says sable on mpa and s resuls n a low onrbuon o s sok o e uy premum. Noe a aloug nvesmens don respond o e sok on mpa aer e nal perod wen onsumpon sars o delne srongly ouseold ave o redue nvesmens n order o preven onsumpon rom allng even urer. Te all n nvesmen s mu larger an e all n onsumpon and oupu meanng a e nvesmen volaly ndued by s sok s mu ger an onsumpons or oupus volaly. 45 Noe owever a s onrbuon o busness yle properes o e model are qu sgnan as an be seen by omparng e IRF n gures 5 and. 46 Te IRF was onsrued w e parameers o e G ase. 47 Ts s a resul o our albraon no a general eaure o e model. Ts albraon was osen sne n our sample perod e Israel eonomy was on average a ne borrower rom abroad see oonoe 8. 35