Near-Rational Equilibria in Heterogeneous-Agent Models: A Verification Method

Abstract

We propose a simulation-based procedure for evaluating approximation accuracy of numerical solutions of general equilibrium models with heterogeneous agents. We measure the approximation accuracy by the magnitude of the welfare loss suffered by agents from following sub-optimal policies. Our procedure allows agents to have knowledge of the future paths of the economy under suitably imposed costs of foresight. This method is general, straightforward to implement, and can be used in conjunction with various solution algorithms. We illustrate our method in two contexts: the incomplete-markets model of Krusell and Smith (1998) and the heterogeneous firm model of Khan and Thomas (2008).