This short paper shows that a New Keynesian model with limited asset market participation can generate a high risk-premium on unlevered equity relative to short-term risk-free bonds and high variability of equity returns driven by monetary policy shocks with zero persistence.

We lay out a small open economy dynamic stochastic general equilibrium (DSGE) model with Markov switching to study the term structure of interest rates. We extend the previous models by opening up the economy and adding a foreign demand channel. As a result, we explain the term structure of...