ARTICLE | Review of Economic Dynamics | Vol.44, 2022

Abstract

We provide an estimated DSGE model of a small open economy with both domestic and international financial market frictions. Firms face credit constraints and trade an intrinsically useless asset. Low foreign interest rates are conducive to bubble formation. An asset bubble provides liquidity and relaxes credit constraints. It provides a powerful amplification and propagation mechanism. Our estimated model based on Bayesian methods explains the high volatilities of consumption and stock prices relative to output, countercyclical trade balance, and procyclical stock prices observed in the Mexican data over the period 1990Q1-2011Q4.(c) 2021 Elsevier Inc. All rights reserved.