- Assessing the accuracy of the aggregate law of motion in models with heterogeneous agents
- Journal of Economic Dynamics & Control
- Volume | Issue number
- 34 | 1
- Pages (from-to)
- Document type
- Faculty of Economics and Business (FEB)
- Amsterdam School of Economics Research Institute (ASE-RI)
This paper shows that the R2 and the standard error have fatal flaws and are inadequate accuracy tests. Using data from a Krusell-Smith economy, I show that approximations for the law of motion of aggregate capital, for which the true standard deviation of aggregate capital is up to 14% (119%) higher than the implied value and which are thus clearly inaccurate, can have an R2 as high as 0.9999 (0.99). Key in generating a more powerful test is that predictions of the aggregate law of motion are not updated with the aggregated simulated individual data.
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