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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. Manuel S. Santos & Adrian Peralta-Alva, 2005. "Accuracy of Simulations for Stochastic Dynamic Models," Econometrica, Econometric Society, vol. 73(6), pages 1939-1976, November.
  2. 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.
  3. Eric R Young, 2005. "Approximate Aggregation," Computing in Economics and Finance 2005 141, Society for Computational Economics.
  4. 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.
  5. 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.
  6. Silos, Pedro, 2007. "Housing, portfolio choice and the macroeconomy," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2774-2801, August.
  7. Algan, Yann & Allais, Olivier & Den Haan, Wouter J., 2010. "Solving the incomplete markets model with aggregate uncertainty using parameterized cross-sectional distributions," Journal of Economic Dynamics and Control, Elsevier, vol. 34(1), pages 59-68, January.
  8. Kjetil Storesletten & Chris Telmer & Amir Yaron, 1996. "Asset pricing with idiosyncratic risk and overlapping generations," Economics Working Papers 405, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 1999.
  9. 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.
  10. Gomes, Francisco J & Michaelides, Alexander, 2007. "Asset Pricing with Limited Risk Sharing and Heterogeneous Agents," CEPR Discussion Papers 6136, C.E.P.R. Discussion Papers.
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  12. Michael Reiter, 2000. "Estimating The Accuracy Of Numerical Solutions To Dynamic Optimization Problems," Computing in Economics and Finance 2000 254, Society for Computational Economics.
  13. 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.
  14. 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.
  15. Makoto Nakajima, 2012. "Business Cycles In The Equilibrium Model Of Labor Market Search And Self‐Insurance," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(2), pages 399-432, 05.
  16. 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.
  17. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
  18. 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.
  19. Jose-Victor Rios-Rull, 1997. "Computation of equilibria in heterogeneous agent models," Staff Report 231, Federal Reserve Bank of Minneapolis.
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