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The importance of the number of different agents in a heterogeneous asset-pricing model

  • Den Haan, Wouter J.

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 idiosyncratic income shocks 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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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 25 (2001)
Issue (Month): 5 (May)
Pages: 721-746

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Handle: RePEc:eee:dyncon:v:25:y:2001:i:5:p:721-746
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  17. Wang, Cheng, 1995. "Dynamic Insurance with Private Information and Balanced Budgets," Staff General Research Papers 5249, Iowa State University, Department of Economics.
  18. Pishke, J.S., 1992. "Individual Income, Incomplete Information and Aggregate Consumption," Papers 9238, Tilburg - Center for Economic Research.
  19. Den Haan, Wouter J, 1996. "Heterogeneity, Aggregate Uncertainty, and the Short-Term Interest Rate," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(4), pages 399-411, October.
  20. Zhang, Harold H., 2000. "Explaining bond returns in heterogeneous agent models: The importance of higher-order moments," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1381-1404, September.
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  23. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc.
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  26. Heaton, John & Lucas, Deborah, 1992. "The effects of incomplete insurance markets and trading costs in a consumption-based asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 601-620.
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