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

  • Den Haan, Wouter J.

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.

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

Volume (Year): 34 (2010)
Issue (Month): 1 (January)
Pages: 79-99

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Handle: RePEc:eee:dyncon:v:34:y:2010:i:1:p:79-99
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Reiter, Michael, 2009. "Solving heterogeneous-agent models by projection and perturbation," Journal of Economic Dynamics and Control, Elsevier, vol. 33(3), pages 649-665, March.
  2. Krusell, P & Smith Jr, A-A, 1995. "Income and Wealth Heterogeneity in the Macroeconomic," RCER Working Papers 399, University of Rochester - Center for Economic Research (RCER).
  3. Storesletten, Kjetil & Telmer, Chris & Yaron, Amir, 2001. "Asset Pricing with Idiosyncratic Risk and Overlapping Generations," CEPR Discussion Papers 3065, C.E.P.R. Discussion Papers.
  4. Den Haan, Wouter J., 1997. "Solving Dynamic Models With Aggregate Shocks And Heterogeneous Agents," Macroeconomic Dynamics, Cambridge University Press, vol. 1(02), pages 355-386, June.
  5. Manuel S. Santos & Adrian Peralta-Alva, 2003. "Accuracy of Simulations for Stochastic Dynamic Models," Levine's Bibliography 666156000000000264, UCLA Department of Economics.
  6. Yann Algan & Olivier Allais & Wouter J Den Haan, 2006. "Solving Heterogeneous-agent Models with Parameterized Cross-sectional Distributions," Sciences Po publications 2006 - 46, Sciences Po.
  7. Per Krusell & Anthony A. Smith, Jr., . "Income and Wealth Heterogeneity, Portfolio Choice, and Equilibrium Asset Returns," GSIA Working Papers 1997-45, Carnegie Mellon University, Tepper School of Business.
  8. Silos, Pedro, 2007. "Housing, portfolio choice and the macroeconomy," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2774-2801, August.
  9. Jose-Victor Rios-Rull, 1997. "Computation of equilibria in heterogeneous agent models," Staff Report 231, Federal Reserve Bank of Minneapolis.
  10. Krueger, Dirk & Kubler, Felix, 2004. "Computing equilibrium in OLG models with stochastic production," Journal of Economic Dynamics and Control, Elsevier, vol. 28(7), pages 1411-1436, April.
  11. Makoto Nakajima, 2006. "Business Cycles in the Equilibrium Model of Labor Search and Self-Insurance," Computing in Economics and Finance 2006 426, Society for Computational Economics.
  12. Yann Algan & Olivier Allais & Wouter J Den Haan, 2010. "Solving the incomplete markets model with aggregate uncertainty using parameterized cross-sectional distributions," Working Papers 31290, Institut National de la Recherche Agronomique, France.
  13. Francisco Gomes & Alexander Michaelides, 2008. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 415-448, January.
  14. Eric R Young, 2005. "Approximate Aggregation," Computing in Economics and Finance 2005 141, Society for Computational Economics.
  15. 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.
  16. Michael Reiter, 2000. "Estimating The Accuracy Of Numerical Solutions To Dynamic Optimization Problems," Computing in Economics and Finance 2000 254, Society for Computational Economics.
  17. Manuel S. Santos, 2000. "Accuracy of Numerical Solutions using the Euler Equation Residuals," Econometrica, Econometric Society, vol. 68(6), pages 1377-1402, November.
  18. Makoto Nakajima, 2010. "Business cycles in the equilibrium model of labor market search and self-insurance," Working Papers 10-24, Federal Reserve Bank of Philadelphia.
  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.
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