Solving General Equilibrium Models with Incomplete Markets and Many Assets

Abstract

This paper presents a new numerical method for solving general equilibrium models with many assets. The method can be applied to models where there are heterogeneous agents, time-varying investment opportunity sets, and incomplete markets. It also can be used to study models where the equilibrium dynamics are non-stationary. We illustrate how the method is used by solving a one-and two-sector versions of a two-country general equilibrium model with production. We check the accuracy of our method by comparing the numerical solution to the one-sector model against its known analytic properties. We then apply the method to the two-sector model where no analytic solution is available.

Home bias and high turnover: Dynamic portfolio choice with incomplete markets

“…Columns (i) and (iii) show that on average more that 80% of the equity issued by tradable firms is held by domestic households. 29 Consistent with the visual evidence in Figure 1, equity holdings are also very volatile.…”

“…When given a choice between two tradable equities (US and ROW), households increase their holdings of the asset whose payoffs are relatively high in states of the world in which the demand for those payoffs is also high. Due to the 29 A small assymetry in the average degree of home bias across countries arises from the denomination of bonds in the model.…”

“…This requires that wealth in each country is included in the state vector, which immediately leads to a number of technical difficulties. 14 The equilibrium of this model is obtained by using a methodology developed in Evans and Hnatkovska (2005b).…”

International Capital Flows

“…This includes all model variables other than the vector k D t of N 1 portfolio share di¤erences and all model equations other than the N 1 portfolio Euler equation di¤erentials (11). 13 From now on 12 (11) is derived under the assumption that the return on asset i is the same for Home and Foreign investors, in terms of the numeraire. The model presented in Section 3 relaxes this assumption by introducing a trading friction, which appears as an additional term in (11).…”

“…But the presence of this additional term does not a¤ect our point that the order O component of (11) does not depend on the order O component of model variables. 13 For model equations and variables that do not involve portfolio choice we simply assume that Conditions 1 and 2 hold as those are standard even in DSGE models without portfolio choice. It is easily veri…ed that Condition 2 holds for the average of portfolio Euler equations.…”