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Understanding Equilibrium Models with a Small and a Large Number of Agents

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  • Wouter J. Den Haan

Abstract

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 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.

Suggested Citation

  • Wouter J. Den Haan, 1996. "Understanding Equilibrium Models with a Small and a Large Number of Agents," NBER Working Papers 5792, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:5792
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    Cited by:

    1. Christiano, Lawrence J. & Fisher, Jonas D. M., 2000. "Algorithms for solving dynamic models with occasionally binding constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 24(8), pages 1179-1232, July.
    2. Heer, Burkhard & Trede, Mark, 2003. "Efficiency and distribution effects of a revenue-neutral income tax reform," Journal of Macroeconomics, Elsevier, vol. 25(1), pages 87-107, March.
    3. Krueger, Dirk & Lustig, Hanno, 2006. "The Irrelevance of Market Incompleteness for the Price of Aggregate Risk," CEPR Discussion Papers 5936, C.E.P.R. Discussion Papers.
    4. Eva Carceles-Poveda, 2009. "Asset Prices and Business Cycles under Market Incompleteness," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 405-422, July.
    5. Heer, Burkhard, 2002. "The German Unemployment Compensation System: Effects on Aggregate Savings and Wealth Distribution," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 48(3), pages 371-394, September.
    6. Krueger, Dirk & Lustig, Hanno, 2010. "When is market incompleteness irrelevant for the price of aggregate risk (and when is it not)?," Journal of Economic Theory, Elsevier, vol. 145(1), pages 1-41, January.
    7. Andreas Hornstein & Harald Uhlig, 2000. "What is the Real Story for Interest Rate Volatility?," German Economic Review, Verein für Socialpolitik, vol. 1(1), pages 43-67, February.
    8. Lettau, Martin, 1998. "Idiosyncratic Risk and Volatility Bounds, or, Can Models with Idiosyncratic Risk Solve the Equity Premium Puzzle?," CEPR Discussion Papers 1795, C.E.P.R. Discussion Papers.

    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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