Solving an Incomplete Markets Model with a Large Cross-Section of Agents

41 Pages Posted: 8 Jun 2011 Last revised: 18 Dec 2017

See all articles by Thomas M. Mertens

Thomas M. Mertens

Federal Reserve Bank of San Francisco

Kenneth L. Judd

Stanford University - The Hoover Institution on War, Revolution and Peace; Center for Robust Decisionmaking on Climate & Energy Policy (RDCEP); National Bureau of Economic Research (NBER)

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Date Written: December 5, 2017

Abstract

This paper shows that perturbation methods can be applied to a DSGE model with incomplete markets and a finite but arbitrarily large number of heterogeneous agents. We develop a simple but general solution technique that handles many state and choice variables for each agent and thus has an extremely high-dimensional state space. The method is based on perturbations around a point at which the solution is known. The novel idea is to exploit the symmetry of the problem to overcome the curse of dimensionality. We use the analysis to demonstrate the impact of heterogeneity on macroeconomic quantities and the pricing of risk. Furthermore, we set our technique apart from standard methods used in the literature.

Keywords: Incomplete Markets, Heterogeneity, Perturbation Methods

Suggested Citation

Mertens, Thomas M. and Judd, Kenneth L., Solving an Incomplete Markets Model with a Large Cross-Section of Agents (December 5, 2017). Available at SSRN: https://ssrn.com/abstract=1859650 or http://dx.doi.org/10.2139/ssrn.1859650

Thomas M. Mertens (Contact Author)

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Kenneth L. Judd

Stanford University - The Hoover Institution on War, Revolution and Peace ( email )

Stanford, CA 94305-6010
United States

Center for Robust Decisionmaking on Climate & Energy Policy (RDCEP) ( email )

5735 S. Ellis Street
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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