Representative Agent Model Research Articles

Searching for preference stability in a state dependent world

We evaluate stability of preference using a randomized intervention that exogenously changes the income opportunity set of participants. We use a unique panel data, comprising of surveys and lab-in-the-field experiments conducted before and after the intervention, to examine whether our elicited measures of preferences (risk, competitiveness, and confidence) remain stable. We find that after accounting for the change in the income opportunity set, the elicited preferences indeed appear to be temporally stable under a state dependent framework. Consequently, even though we find across subject variation in preferences, the average measure of preferences remain temporally stable, providing support to a representative agent model of decision-making with temporally stable preferences.

On Substitutability and Complementarity in Discrete Choice Models

In this paper, we propose the concepts of substitutability and complementarity in discrete choice models. These concepts concern whether the choice probability of one alternative in a choice model increases or decreases with the utility of another alternative, and they play important roles in capturing certain practical choice patterns, such as the halo effect. We study conditions on discrete choice models that will lead to substitutability and complementarity. Particularly, we show that the random utility model only allows substitutability between different alternatives, while the representative agent model and the welfare-based choice model allow more flexible substitutability/complementarity patterns. We also present ways of constructing choice models that exhibit complementary property.

Discovering Traders’ Heterogeneous Behavior in High-Frequency Financial Data

This paper develops a utility-based heterogeneous agent model for empirically investigating intraday traders’ behaviors. Two types of agents, which consist of fundamental traders and technical analysts, are considered in the proposed model. They differ in the expectation of future asset returns and the perceived risk. This paper incorporates the unique characteristics of high-frequency data into the model for the purpose of having a reliable and accurate empirical result. In particular, a two-test procedure is developed to test the market fractions hypothesis that distinguishes the heterogeneous agent model from the representative agent model. The proposed heterogeneous agent model is estimated on the Taiwan Stock Exchange data. The results suggest that fundamental traders expect the correction of over- or under-pricing in the future. Technical analysts act as contrarian traders. Technical analysts also believe that buyer-initiated (seller-initiated) trading will further raise (lower) future prices. The bid-ask spread has a crucial effect on the investment risk for the technical analysts. Moreover, technical analysts are short-sighted, have less market fraction, but perform slightly better.

When Inequality Matters for Macro and Macro Matters for Inequality

We develop an efficient and easy-to-use computational method for solving a wide class of general equilibrium heterogeneous agent models with aggregate shocks, together with an open source suite of codes that implement our algorithms in an easy-to-use toolbox. Our method extends standard linearization techniques and is designed to work in cases when inequality matters for the dynamics of macroeconomic aggregates. We present two applications that analyze a two-asset incomplete markets model parameterized to match the distribution of income, wealth, and marginal propensities to consume. First, we show that our model is consistent with two key features of aggregate consumption dynamics that are difficult to match with representative agent models: (i) the sensitivity of aggregate consumption to predictable changes in aggregate income and (ii) the relative smoothness of aggregate consumption. Second, we extend the model to feature capital-skill complementarity and show how factor-specific productivity shocks shape dynamics of income and consumption inequality.

Comment

Comment

Negotiating environmental agreements under ratification constraints

We analyze the impact of ratification constraints on the optimal terms of international environmental agreements (IEAs). For this, we combine the literature on IEAs with the public choice literature on two-level games. By also incorporating uncertain preferences of the pivotal voter in the ratification stage, we make several important contributions: (i) we contribute to a more realistic modeling of the temporal structure of international agreements, (ii) we show a surprising, yet intuitive non-monotonic relationship between the optimal commitment level and the variance of ratification decisions, (iii) we identify reasons to expect a larger number of countries to join international negotiations than predicted by most of the coalition formation literature based on a representative agent model. Ratification constraints thereby can improve the welfare gains from stable international agreements.

Parameter Uncertainty: The Missing Piece of the Liquidity Premium Puzzle?

I analyze a dynamic investment problem with stochastic transaction cost and parameter uncertainty. I solve the problem numerically and obtain the optimal consumption and investment policy and the least-favorable transaction cost process. Using reasonable parameter values, I confirm the liquidity premium puzzle, i.e., the representative agent model (without robustness) produces a liquidity premium which is by a magnitude lower than the empirically observed value. I show that my model with robust investors generates an additional liquidity premium component of 0.05%-0.10% (depending on the level of robustness) for the first 1% proportional transaction cost, and thus it provides a partial explaination to the liquidity premium puzzle. Additionally, I provide a novel non-recursive representation of discrete-time robust dynamic asset allocation problems with transaction cost, and I develop a numerical technique to efficiently solve such investment problems.

Mixed Integer Programming Revealed Preference Tests of Utility Maximization and Weak Separability of Consumption, Leisure, and Money

Swofford and Whitney (1987, 1988, 1994) investigated the validity of two key assumptions underlying representative agent models of macroeconomics. These assumptions are utility maximization and weak separability. Using mixed integer programming, we check revealed preference conditions for these assumptions. We find that M1, money defined by Friedman and Schwartz (1963), and a broad aggregate are weakly separable. We find that consumption goods and leisure and nondurables and services are weakly separable. We find that M2, M3, and MZM are not weakly separable. Finally, we find three categories of consumption, durables, nondurables and services, do not form an aggregate.

On the Microfoundations of Money Supply Adjustments: An Essay in Loanable Fundamentalism

Discussions of adjustments to the quantity of money tend to take for granted the method by which new money enters the economy. Milton Friedman, for example, famously assumed the central bank distributed money directly to agents via helicopter in order to abstract away from relative price effects, in contrast to the real world, where expansion almost always takes place through financial markets. This paper compares the distribution and relative price effects of expansion by helicopter and through financial markets. The distribution effects of the former will in fact be more severe than those of the latter, except in the sort of representative agent model Friedman used. This result is illustrated using an agent-based model in order to introduce heterogeneity in the demand for cash balances. Finally, we argue the helicopter metaphor is relevant to the emerging literature on money supply norms for crypto-currencies, which – unlike any modern currencies – must distribute changes in the money supply without the use of financial markets.

A representative agent asset pricing model with heterogeneous beliefs and recursive utility

In this paper, we consider a continuous-time pure exchange economy with multiple agents whose preferences are represented by a time-inseparable recursive utility. Agents are homogeneous in their preferences, but heterogeneous in their beliefs regarding the drift rate of the aggregate endowment process. Given a competitive equilibrium in this economy, we construct a tractable representative agent model that would approximate asset prices in the original multiple agents economy. We show that our model helps resolve many asset pricing puzzles, such as the equity premium puzzle, equity volatility puzzle, risk-free rate puzzle, and term premium puzzle.

On the Aggregate Labor Supply: A Progress Report

At the aggregate level, the labor supply elasticity can significantly depart from the micro elasticity. In an economy where households make decisions on the labor market participation, the slope of the aggregate labor supply curve is determined by the distribution of reservation wages rather than by the willingness to substitute leisure intertemporally. We present a model economy where earnings and wealth distributions are comparable to those in the micro data. We find that the aggregate labor supply elasticity of such an economy is around 1, which is greater than the typical micro estimates but smaller than those often assumed in the aggregate models. Our model also sheds some light on the recent debate on the failure of the representative agent model.

Fiscal Policy in a Growing Economy with Financial Frictions and Firm Heterogeneity

This paper constructs a tractable model of endogenous growth with financial frictions and firm heterogeneity. We introduce factor income tax, consumption tax as well as the government consumption into the base model and explore the growth effect of fiscal policy. We show that from the qualitative perspective, the long-run effects of fiscal actions in our model are similar to those obtained in the representative agent models. However, the quantitative impacts of fiscal policy on long-run growth in our setting can be substantially different from those established in the model where agents are homogeneous and there is no financial frictions.

Discussion

Discussion

Optimal Ramsey taxation with hidden actions

Purpose – The purpose of this paper is to study the problem of optimal Ramsey taxation in a finite-planning-horizon, representative-agent endogenous growth model including government expenditures as a productive input in capital formation and also with hidden actions. Design/methodology/approach – Technically, Malliavin calculus and forward integrals are naturally introduced into the macroeconomic theory when economic agents are faced with different information structures arising from a non-Markovian environment. Findings – The major result shows that the well-known Judd-Chamley Theorem holds almost surely if the depreciation rate is strictly positive, otherwise Judd-Chamley Theorem only holds for a knife-edge case or on a Lebesgue measure-zero set when the physical capital is completely sustainable. Originality/value – The author believes that the approach developed as well as the major result established is new and relevant.

Reductionism in Economics: Intentionality and Eschatological Justification in the Microfoundations of Macroeconomics

Macroeconomists overwhelmingly believe that macroeconomics requires microfoundations, typically understood as a strong eliminativist reductionism. Microfoundations aims to recover intentionality. In the face of technical and data constraints macroeconomists typically employ a representative-agent model, in which a single agent solves the microeconomic optimization problem for the whole economy, and take it to be microfoundationally adequate. The characteristic argument for the representative-agent model holds that the possibility of the sequential elaboration of the model to cover any number of individual agents justifies treating the policy conclusions of the single-agent model as practically relevant. This eschatological justification is examined and rejected.

On the macroeconomic effects of heterogeneous productivity shocks

AbstractThe conventional wisdom that producer heterogeneity washes out, and is therefore irrelevant for the aggregate economy, does not apply when producers compete monopolistically. Despite this, the effects of such heterogeneity can be reproduced with an appropriately redefined representative-agent framework where the equilibrium values of aggregates are expressed in terms of the moment generating function of the distribution of heterogeneity, or its asymptotic distribution. Increased heterogeneity raises aggregate productivity and production, more so the fiercer competition is. We propose a framework where the entire distribution of heterogeneity matters, yet computationally requires no more than a representative-agent model.

Layoff Risk, the Welfare Cost of Business Cycles, and Monetary Policy

The strongest predictor of changes in the Fed Funds rate in the period 1982–2008 was the layoff rate. That fact is puzzling from the perspective of representative-agent models of the economy, which imply that the welfare gains of stabilizing employment fluctuations are small. This paper augments a standard New Keynesian model with a labor market featuring countercyclical layoffs that lead to large,uninsurable, and permanent idiosyncratic wage declines. In our benchmark calibration, welfare may be increased by 1 percent of lifetime consumption or more when the central bank’s policy rule responds to the layoff rate instead of purely targeting inflation.

Is It Time to Raise the Gas Tax? Optimal Gasoline Taxes for Ontario and Toronto

This article uses a representative agent model and Canadian data to calculate the optimal gasoline taxes for Ontario and the Greater Toronto-Hamilton Area (GTHA) in a second-best setting with pre-existing distortionary income taxes. The results suggest a second-best optimal gasoline tax of 40.57 cents per litre in 2006 Canadian dollars for the GTHA that is much higher than the current tax rate of 24.7 cents per litre, and also higher than recently proposed increases. The resulting value is insensitive to whether the additional revenue is used to reduce taxes on income or to incrementally fund increased public transit infrastructure (the Big Move plan). However, in the absence of a regional tax, the second-best optimal gasoline tax for Ontario as a whole of 28.51 cents per litre in 2006 Canadian dollars is slightly higher than the current tax rate and in line with proposed increases.

Water pricing reform analysis: alternative scenarios

This paper compares alternative transition paths to efficient water pricing. The analysis is based on representative agent model, where two sources of water supply exist: exhaustible groundwater stock and a renewable substitute. Two alternative water pricing reforms are considered: gradual tariff increase and multipart pricing with first block sold at the initial pre-reform tariff and additional water sold at higher prices (block pricing reform). Under block pricing reform, the amount of water offered at low price gradually diminishes. The results of comparative analysis prove that under the same reform time horizon block pricing is preferred to the gradual tariff increase.

Aggregate Implications of a Credit Crunch: The Importance of Heterogeneity

We take an off-the-shelf model with financial frictions and heterogeneity, and study the mapping from a credit crunch, modeled as a shock to collateral constraints, to simple aggregate wedges. We study three variants of this model that only differ in the form of underlying heterogeneity. We find that in all three model variants a credit crunch shows up as a different wedge: efficiency, investment, and labor wedges. Furthermore, all three model variants have an undistorted Euler equation for the aggregate of firm owners. These results highlight the limitations of using representative agent models to identify sources of business cycle fluctuations. (JEL E22, E23, E32, E43, E44)