The Time-Interlaced Self-Consistent Master System of Heterogeneous-Agent Models

Abstract

It is shown that the structure of general equilibrium incomplete market models is intrinsically self-consistent and time-interlaced, with mean field interactions that are only implicit and also endogenous. Novel mathematical tools that can handle such structures and do not rely on the representative agent point of view are developed. The study was prompted by the surprising discovery that the common strategy for resolving the classical Aiyagari-Bewley-Huggett model fails to achieve its objective in a widely cited benchmark study. In addition to providing a numerically verifiable solution to such models, the scope of the approximate aggregation conjecture of Krusell and Smith (still an open problem in macroeconomics) is clarified. New features of Krusell-Smith's model are uncovered and novel computational technique, which does not involve simulation, is developed.