Non-Stationarity and Instability in Small Open-Economy Models Even When They Are "Closed.".

In this article, the author looks at the standard small open-economy model with incomplete international asset markets. The author shows that commonly used specifications of the risk premium do not lead to equilibrium determinacy problems. He then derives an analytical solution for the canonical small open-economy model which tries to illuminate the extent of the unit-root problem. He also studies the determinacy properties of the model when a stationarity-inducing risk-premium is introduced. Moreover, the author offers an alternative solution to the unit-root problem via portfolio adjustment costs.