Idiosyncratic Shocks, Aggregate Fluctuations And The Representative Consumer

This paper analyzes a complete market neoclassical economy with heterogeneous agents. Agents have addilog preferences and receive idiosyncratic labor productivity shocks. We show that at the aggregate level, such an economy behaves as if there was the representative consumer who faces shocks to preferences and technology. This fact enables us to infer time-series properties of the model without specifying a process for idiosyncratic shocks. Instead, we calibrate the process for shocks to preferences and technology in the model derived from aggregation. In contrast to the standard one-shock setup, the model with two types of shocks can generate the appropriate predictions with respect to labor markets.