Recursive equilibria in an Aiyagari style economy with permanent income shocks

Moritz Kuhn

MPRA Paper from University Library of Munich, Germany

Abstract: In this paper, we prove the existence of a recursive competitive equilibrium (RCE) for an Aiyagari style economy with permanent income shocks and perpetual youth structure. We show that there exist equilibria where borrowing constraints are never binding. This allows us to establish a non-trivial lower bound on the equilibrium interest rate. To solve the individual’s problem, we present a new approach that uses lattices of consumption functions to deal with the non-compact state space and the unbounded utility function. The approach uses only the first order conditions of the problem (Euler equations). The proof is constructive and it serves as a theoretical foundation for the convergence of a policy function iteration procedure.

Keywords: Permanent income shocks; incomplete markets; dynamic general equilibrium; heterogeneous agents (search for similar items in EconPapers)
JEL-codes: D51 D52 E21 (search for similar items in EconPapers)
Date: 2008-12-12, Revised 2009-12-09
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