Applying the Explicit Aggregation Algorithm to Heterogeneous Firm Models: With an Application to Estimating the Aggregate Technology Shock Process

Abstract

This paper applies the explicit aggregation algorithm developed by Den Haan and Rendahl [2010. Solving the incomplete markets model with aggregate uncertainty using explicit aggregation. Journal of Economic Dynamics and Control, 69-78] to heterogeneous firm models studied in Khan and Thomas [2008. Idiosyncratic shocks and the role of nonconvexities in plant and aggregate investment dynamics. Econometrica 76, 395-436]. The explicit aggregation algorithm can solve heterogeneous firm models in less computational time without simulating the plants distribution. Although the individual decision rules exhibit high nonlinearity, the simulation results in terms of the aggregate-level and plant-level moments are comparable between the explicit aggregation algorithm and the standard Krusell and Smith algorithm. This paper also estimates the aggregate technology shock process by using the simulated method of moments to match the aggregate moments. The estimated values of parameters are close to the ones estimated by the Solow residual.