<p>This paper estimates a DSGE model with financial frictions and hybrid expectations, a novelty in modelling small open economy within a monetary union. We find that both features improve the in-sample fit. Forecast error variance decompositions indicate that dampening the endogenous mechanics of financial frictions shifts the influence of financial shocks on real loans to non-financial corporations, real investments, and domestic nominal interest rates toward demand and foreign shocks. Adding hybrid expectations, in turn, amplifies the effects of demand and supply shocks across most observed variables, while diminishing the role of foreign and financial shocks. Analysis of impulse response functions suggests that hybrid expectations have a greater impact on the persistence and magnitudes of economic responses than the endogenous mechanics of financial frictions. Despite superior in-sample fit, hybrid expectations do not enhance forecasting accuracy over an eight-quarters ahead horizon, particularly for real GDP. Moreover, financial frictions offer somewhat modest forecasting gains, contributing to ongoing debates about their value during periods of financial stability.</p>