Implications of Aggregate and Idiosyncratic Shocks for Neoclassical Growth and Wealth Distribution

Master Thesis by Ali Kivilcim Özdagli
July 27, 2004


The aim of this paper is to examine the effects of aggregate and individual shocks on the dynamics of wealth distribution and macroeconomic variables. For this purpose, the stochastic neoclassical representative agent model is extended to an economy populated by heterogeneous agents with partially uninsurable idiosyncratic risks. Agents differ in their labor productivity and capital endowments whose steady state distributions are given exogenously. Using log-linear approximation around the steady state it is shown that the effects of aggregate shocks depend on the degree of heterogeneity and preferences. Nevertheless, idiosyncratic shocks impose a consistent antagonistic relationship between different types of agents where those experiencing a positive shock are better off leaving the others worse off. Moreover, it is found that agents do not care about the distribution of wealth beyond its mean while making their decisions. In addition, the business cycle properties of the heterogeneous economy are distinguished from those of the corresponding representative agent framework if the persistence of idiosyncratic productivity shocks differs significantly from the persistence of the aggregate technology shock. Given these results, one may conclude that it is time to deviate from the representative agent assumption.