Department of Economics
1022 International Affairs Building
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New York, NY 10027
NBER Working Papers and Publications
|July 2007||Incomplete Markets, Heterogeneity and Macroeconomic Dynamics|
with Bruce Preston: w13260
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 propert...