TY  - JOUR
AU  - Preston,Bruce
AU  - Roca,Mauro
TI  - Incomplete Markets, Heterogeneity and Macroeconomic Dynamics
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13260
PY  - 2007
Y2  - July 2007
UR  - http://www.nber.org/papers/w13260
L1  - http://www.nber.org/papers/w13260.pdf
N1  - Author contact info:
Bruce Preston
Department of Economics
Columbia University
420 West 118th Street
New York, NY 10027
Tel: 212/854-4092
Fax: 212/854-8059
E-Mail: bp2121@columbia.edu

Mauro Roca
Department of Economics
Columbia University
1022 International Affairs Building
420 West 118th Street
New York, NY 10027
Tel: 212-6659437
Fax: 212-6659437
E-Mail: mfr2004@columbia.edu
AB  - This 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.
ER  -