Solving OLG Models with Many Cohorts, Asset Choice and Large Shocks

Michael Reiter

No 320, Economics Series from Institute for Advanced Studies

Abstract: The paper presents a computationally efficient method to solve overlapping generations models with asset choice. The method is used to study an OLG economy with many cohorts, up to 3 different assets, stochastic volatility, short-sale constraints, and subject to rather large technology shocks. On the methodological side, the main findings are that global projection methods with polynomial approximations of degree 3 are sufficient to provide a very precise solution, even in the case of large shocks. Globally linear approximations, in contrast to local linear approximations, are sufficient to capture the most important financial statistics, including not only the average risk premium, but also the variation of the risk premium over the cycle. However, global linear approximations are not sufficient to reliably pin down asset choices. With a risk aversion parameter of only 4, the model generates a price of risk, measured as the Sharpe ratio, that is almost half of what it is for US stocks. However, the asset price fluctuations and the equity premium are much smaller than in US data.

Keywords: OLG models; asset choice; projection methods (search for similar items in EconPapers)
JEL-codes: C63 C68 E21 G11 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2015-12
New Economics Papers: this item is included in nep-cmp, nep-dge and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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https://irihs.ihs.ac.at/id/eprint/3875 First version, 2015 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:ihs:ihsesp:320

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