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Understanding Equilibrium Models with a Small and a Large Number of Agents

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  • Wouter J. Den Haan

Abstract

In this paper, I compare a two-agent asset pricing model with the corresponding model with a continuum of agents. In a two-agent economy, interest rates respond to because each agent represents half of the population. These interest rate effects facilitate consumption smoothing. An agent in a two-agent economy, however, can never lend more than the other agent is allowed to borrow, which prevents him from building a buffer stock of assets. For most parameter values, the first effect is more important. For some parameter values, the interest rate effects in the two-agent economy are so strong that a relaxation of the borrowing constraint reduces an agent's utility. In contrast to these differences, I find that for most parameter values there are no large differences in average interest rates across the two types of economies. In addition, I analyze the business cycle behavior of interest rates in an incomplete markets economy with a continuum of agents. The dynamic response of interest rates to aggregate shocks is a lot more complicated than the response in a complete markets economy and the magnitude of the response is bigger.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5792.

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Date of creation: Oct 1996
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Handle: RePEc:nbr:nberwo:5792

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Cited by:
  1. Dirk Krueger & Hanno Lustig, 2006. "When is Market Incompleteness Irrelevant for the Price of Aggregate Risk (and when is it not)?," NBER Working Papers 12634, National Bureau of Economic Research, Inc.
  2. Krüger, Dirk & Lustig, Hanno, 2006. "The Irrelevance of Market Incompleteness for the Price of Aggregate Risk," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5936, C.E.P.R. Discussion Papers.
  3. Eva Carceles-Poveda, 2009. "Asset Prices and Business Cycles under Market Incompleteness," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 405-422, July.
  4. Lawrence J. Christiano & Jonas D.M. Fisher, 1997. "Algorithms for solving dynamic models with occasionally binding constraints," Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago WP-97-15, Federal Reserve Bank of Chicago.
  5. Andreas Hornstein & Harald Uhlig, 2000. "What is the Real Story for Interest Rate Volatility?," German Economic Review, Verein für Socialpolitik, Verein für Socialpolitik, vol. 1(1), pages 43-67, 02.
  6. Heer, Burkhard, 2002. "The German Unemployment Compensation System: Effects on Aggregate Savings and Wealth Distribution," Review of Income and Wealth, International Association for Research in Income and Wealth, International Association for Research in Income and Wealth, vol. 48(3), pages 371-94, September.
  7. Martin Lettau, 2001. "Idiosyncratic risk and volatility bounds, or can models with idiosyncratic risk solve the equity premium puzzle?," Staff Reports, Federal Reserve Bank of New York 130, Federal Reserve Bank of New York.
  8. Heer, Burkhard & Trede, Mark, 2003. "Efficiency and distribution effects of a revenue-neutral income tax reform," Journal of Macroeconomics, Elsevier, Elsevier, vol. 25(1), pages 87-107, March.
  9. Lettau, Martin & Uhlig, Harald, 1997. "Preferences, Consumption Smoothing, and Risk Premia," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1678, C.E.P.R. Discussion Papers.

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