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Approximate and Almost-Exact Aggregation in Dynamic Stochastic Heterogeneous-Agent Models

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  • Reiter, Michael

    (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)

Abstract

The paper presents a new method to solve DSGE models with a great number of heterogeneous agents. Using tools from systems and control theory, it is shown how to reduce the dimension of the state and the policy vector so that the reduced model approximates the original model with high precision. The method is illustrated with a stochastic growth model with incomplete markets similar to Krusell and Smith (1998), and with a model of heterogeneous firms with state-dependent pricing. For versions of those models that are nonlinear in individual variables, but linearized in aggregate variables, approximations with 50 to 200 state variables deliver solutions that are precise up to machine precision. The paper also shows how to reduce the state vector even further, with a very small reduction in precision.

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File URL: http://www.ihs.ac.at/publications/eco/es-258.pdf
File Function: First version, 2010
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Bibliographic Info

Paper provided by Institute for Advanced Studies in its series Economics Series with number 258.

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Length: 49 pages
Date of creation: Oct 2010
Date of revision:
Handle: RePEc:ihs:ihsesp:258

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Related research

Keywords: Heterogeneous agents; aggregation; model reduction;

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References

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  1. Fatih Guvenen, 2007. "An empirical investigation of labor income processes," IFS Working Papers W07/13, Institute for Fiscal Studies.
  2. Benjamin Malin & Dirk Krueger & Felix Kubler, 2007. "Computing Stochastic Dynamic Economic Models with a Large Number of State Variables: A Description and Application of a Smolyak-Collocation Method," NBER Working Papers 13517, National Bureau of Economic Research, Inc.
  3. Bruce Preston & Mauro Roca, 2007. "Incomplete Markets, Heterogeneity and Macroeconomic Dynamics," NBER Working Papers 13260, National Bureau of Economic Research, Inc.
  4. Anton Nakov & James Costain, 2009. "Dynamics of the Price Distribution in a General Model of State-Dependent Pricing," 2009 Meeting Papers 611, Society for Economic Dynamics.
  5. Per Krusell & Anthony A. Smith, Jr., . "Income and Wealth Heterogeneity in the Macroeconomy," GSIA Working Papers 1997-37, Carnegie Mellon University, Tepper School of Business.
  6. Michael Reiter, 2006. "Solving heterogeneous-agent models by projection and perturbation," Economics Working Papers 972, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Michael Reiter & Tommy Sveen & Lutz Weinke, 2009. "Lumpy investment and state-dependent pricing in general equilibrium," Working Paper 2009/05, Norges Bank.
  8. Den Haan, Wouter J. & Rendahl, Pontus, 2010. "Solving the incomplete markets model with aggregate uncertainty using explicit aggregation," Journal of Economic Dynamics and Control, Elsevier, vol. 34(1), pages 69-78, January.
  9. Ana Castaneda & Javier Diaz-Gimenez & Jose-Victor Rios-Rull, 2003. "Accounting for the U.S. Earnings and Wealth Inequality," Journal of Political Economy, University of Chicago Press, vol. 111(4), pages 818-857, August.
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Cited by:
  1. Reiter, Michael & Sveen, Tommy & Weinke, Lutz, 2013. "Lumpy investment and the monetary transmission mechanism," Journal of Monetary Economics, Elsevier, vol. 60(7), pages 821-834.

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