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Assessing the accuracy of the aggregate law of motion in models with heterogeneous agents

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  • Den Haan, Wouter J.

Abstract

This paper shows that the R2 and the standard error have fatal flaws and are inadequate accuracy tests. Using data from a Krusell-Smith economy, I show that approximations for the law of motion of aggregate capital, for which the true standard deviation of aggregate capital is up to 14% (119%) higher than the implied value and which are thus clearly inaccurate, can have an R2 as high as 0.9999 (0.99). Key in generating a more powerful test is that predictions of the aggregate law of motion are not updated with the aggregated simulated individual data.

Suggested Citation

  • Den Haan, Wouter J., 2010. "Assessing the accuracy of the aggregate law of motion in models with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 34(1), pages 79-99, January.
    • Handle: RePEc:eee:dyncon:v:34:y:2010:i:1:p:79-99
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    1. 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.
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    Keywords

    Numerical solutions Simulations Approximations;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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