Two main themes run through the papers in this dissertation. Firstly, the papers discuss the spillovers of policy choices made by large countries on small open economies. Secondly, the papers challenge some of the basic assumptions that have been widely used by open economy models.;In analyzing the influence of external shocks on small open economies, the current literature takes the outside world as exogenous. The first essay questions this assumption and demonstrates that a three-country framework is more appropriate to analyze the influence of external shocks than the current framework. Introducing other countries into this analysis helps us quantify the relative importance of the shocks that are transmitted to small countries after passing through another country. Moreover, it allows incorporating the role of large-country monetary policy choices in influencing the shocks that are transmitted to the small open economies. The game-theoretic component of the model analyzing the interactions among large countries indicates that shocks transmitted to small countries depend upon the degree of coordination among large countries. The simulation results show that shocks that are transmitted to the small open economy through trading partners create significant volatility for the small economy.;Another commonly used assumption is the uncovered interest parity assumption. The second essay starts from a basic observation: high ratios of banking sector concentration are very common among developing countries. The essay then tests the relationship between this observation and the deviations from uncovered interest parity. The theoretical model developed demonstrates that countries with greater market power in domestic financial institutions will have the ability to discourage financial flows through their manipulation of domestic interest rates. In these markets, domestic lenders' use of their market power leads to a different correlation between financial flows and excess returns as compared to those suggested by traditional models. I find that convergence in interest rates in these markets is a result of collusive behavior. My panel data estimation indicates that there is significant evidence of the impact of financial market concentration on the relation between excess returns and the volume of the financial flows.
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