We propose a general simulation-based procedure for estimating the quality of approximate policies in heterogeneous-agent equilibrium models, which allows us to verify that such approximate solutions describe a near-rational equilibrium. Our procedure endows agents with superior knowledge of the future path of the economy, while imposing a suitable penalty for such foresight. The relaxed problem is more tractable than the original, and results in an upper bound on agents’ welfare. Our method applies to various solution algorithms. We illustrate our approach in two applications: the incomplete-markets model of Krusell and Smith (1998) and the heterogeneous firm model of Khan and Thomas (2008).

We present a theory in which the interaction between limited sharing of idiosyncratic labor income risk and labor adjustment costs (that endogenously arise through search frictions) determines interest rate dynamics. In the general equilibrium, the interaction of these two ingredients relates bond risk premiums, cross-sectional skewness of income growth, and labor market tightness. Our model rationalizes an upward-sloping average yield curve and predicts a negative relation between labor market tightness and bond risk premiums. We provide evidence for our theory’s mechanism and predictions.

We show that time-varying risk premium in financial markets can explain a key, yet puzzling, feature of labor markets: the large differences in unemployment risk across worker age groups over the business cycle. Our search model features a time-varying risk premium and learning about unobserved heterogeneity in worker productivity. Their interaction generates large real effects through firms’ labor policies. Our model predicts higher unemployment risk of younger workers relative to prime-age workers when risk premium is high, and the employment ratio of prime-age to young workers to be more cyclical in high beta industries. We find empirical support for these predictions.