02572cam a22002897 4500001000700000003000500007005001700012008004100029100002000070245011800090260006600208490004200274500001500316520119000331530006101521538007201582538003601654690013901690690006801829690008901897690008501986700001702071710004202088830007702130856003802207856003702245w13260NBER20140829121357.0140829s2007 mau||||fs|||| 000 0 eng d1 aPreston, Bruce.10aIncomplete Markets, Heterogeneity and Macroeconomic Dynamicsh[electronic resource] /cBruce Preston, Mauro Roca. aCambridge, Mass.bNational Bureau of Economic Researchc2007.1 aNBER working paper seriesvno. w13260 aJuly 2007.3 aThis paper solves a real business cycle model with heterogeneous agents and uninsurable income risk using perturbation methods. A second order accurate characterization of agent's optimal decision rules is given, which renders the implications of aggregation for macroeconomic dynamics transparent. The role of cross-sectional holdings of capital in determining equilibrium dynamics can be directly assessed. Analysis discloses that an individual's optimal saving decisions are almost linear in their own capital stock giving rise to permanent income consumption behavior. This provides an explanation for the approximate aggregation properties of this model documented by Krusell and Smith (1998): the distribution of capital does not affect aggregate dynamics. While the variance-covariance properties of endogenous variables are almost entirely determined by first order dynamics, the second order dynamics, which capture properties of the wealth distribution, are nonetheless important for an individual's mean consumption and saving decisions and therefore the mean equilibrium capital stock. Policy evaluation exercises therefore need to take account of these higher order terms. aHardcopy version available to institutional subscribers. aSystem requirements: Adobe [Acrobat] Reader required for PDF files. aMode of access: World Wide Web. 7aC6 - Mathematical Methods • Programming Models • Mathematical and Simulation Modeling2Journal of Economic Literature class. 7aD52 - Incomplete Markets2Journal of Economic Literature class. 7aE21 - Consumption • Saving • Wealth2Journal of Economic Literature class. 7aE32 - Business Fluctuations • Cycles2Journal of Economic Literature class.1 aRoca, Mauro.2 aNational Bureau of Economic Research. 0aWorking Paper Series (National Bureau of Economic Research)vno. w13260.4 uhttp://www.nber.org/papers/w1326041uhttp://dx.doi.org/10.3386/w13260