The importance of the number of different agents in a heterogeneous asset-pricing model

Models with heterogeneous agents and incomplete markets often only have two types of agents to limit the computational complexity. The question arises whether equilibrium models with a realistic number of types have the same implications as models with a small number of types. In the asset-pricing model considered in this paper, several properties depend crucially on the number of types. For example, in the economy with only two types interest rates respond to 'idiosyncratic' income shocks which makes it easier to smooth consumption. Moreover these effects can be so strong that it is possible that a relaxation of the borrowing constraint reduces an agent's utility. Average interest rates on the other hand are not very sensitive to the number of types. (C) 2001 Elsevier Science B.V. All rights reserved.