Approximate versus exact equilibria in dynamic economies

Felix Kubler*, Karl Schmedders

*Corresponding author for this work

Research output: Contribution to journalArticle

19 Scopus citations

Abstract

This paper develops theoretical foundations for an error analysis of approximate equilibria in dynamic stochastic general equilibrium models with heterogeneous agents and incomplete financial markets. While there are several algorithms that compute prices and allocations for which agents' first-order conditions are approximately satisfied ("approximate equilibria"), there are few results on how to interpret the errors in these candidate solutions and how to relate the computed allocations and prices to exact equilibrium allocations and prices. We give a simple example to illustrate that approximate equilibria might be very far from exact equilibria. We then interpret approximate equilibria as equilibria for close-by economies; that is, for economies with close-by individual endowments and preferences. We present an error analysis for two models that are commonly used in applications, an overlapping generations (OLG) model with stochastic production and an asset pricing model with infinitely lived agents. We provide sufficient conditions that ensure that approximate equilibria are close to exact equilibria of close-by economies. Numerical examples illustrate the analysis.

Original languageEnglish (US)
Pages (from-to)1205-1235
Number of pages31
JournalEconometrica
Volume73
Issue number4
DOIs
StatePublished - Jul 1 2005

Keywords

  • Approximate equilibria
  • Backward error analysis
  • Computational economics
  • Dynamic stochastic general equilibrium
  • Perturbed economy

ASJC Scopus subject areas

  • Economics and Econometrics

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