Near-Rational Equilibria in Heterogeneous-Agent Models: A Verification Method

40 Pages Posted: 13 Jul 2021

See all articles by Leonid Kogan

Leonid Kogan

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Indrajit Mitra

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2021

Abstract

We propose a general simulation-based procedure for estimating the quality of approximate policies in heterogeneous-agent equilibrium models, which allows verification that such approximate solutions describe a near-rational equilibrium. Our procedure endows agents with superior knowledge of the future path of the economy, while imposing a suitable penalty for such foresight. The relaxed problem is more tractable than the original, and it results in an upper bound on agents’ welfare. Our method is general and straightforward to implement, and it can be used in conjunction with various solution algorithms. We illustrate our approach in two applications: the incomplete-markets model of Krusell and Smith (1998) and the heterogeneous firm model of Khan and Thomas (2008).

JEL Classification: E24, E62, J22

Suggested Citation

Kogan, Leonid and Mitra, Indrajit, Near-Rational Equilibria in Heterogeneous-Agent Models: A Verification Method (June 1, 2021). FRB Atlanta Working Paper No. 2021-16, Available at SSRN: https://ssrn.com/abstract=3885373 or http://dx.doi.org/10.29338/wp2021-16

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Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Indrajit Mitra

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