State Reduction and Second-order Perturbations of Heterogeneous Agent Models

Reiter, MichaelORCID: (August 2023) State Reduction and Second-order Perturbations of Heterogeneous Agent Models. IHS Working Paper Series 49, 43 p.

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This paper develops a method to compute second-order perturbations of discretetime heterogeneous agent models. It addresses the three main tasks to make second-order approximations tractable: state reduction, generating sufficient smoothness, and fast computation of the quadratic terms in the perturbation solution. The method is applied to a model with divisible labor, one with indivisible labor, and to an OLG model with stochastic aging. Compared to a linearized solution, second-order perturbations achieve substantially higher accuracy if models are subject to large or medium-sized aggregate shocks. They also capture precautionary behavior with respect to aggregate shocks. A general method of state reduction is developed, called ”conditional-expectations approach”. In the example models, it performs better in terms of accuracy and reliability than alternative approaches.

Item Type: IHS Series
Additional Information (public): Including an Online-Appendix of 21 pages.
Keywords: heterogeneous agents, model reduction, perturbation methods
Funders: Anniversary Fund, Austrian National Bank (OeNB)
Classification Codes (e.g. JEL): C63, C68, E21
Research Units: Current Research Groups > Macroeconomics and Business Cycles
Related URLs:
Date Deposited: 21 Aug 2023 10:05
Last Modified: 03 May 2024 11:02

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