A criterion for time aggregation in intertemporal dynamic models

Nonlinear intertemporal general equilibrium models are hard to solve because of the dimensionality of the optimization problem involved. The computation of intertemporal general equilibria therefore calls for time-aggregation assumptions. A question then immediately arises: what criterion should one use to choose a sequence of possibly unequal time intervals in order to reduce the dimensionality of the optimization problem, yet keep under control the errors resulting from the numerical approximation of a continuous time process by a discrete time process? We propose one such criterion based on the current value of capital, which exploits near steady-state optimal dynamics. We show, using a parameterized version of the standard Ramsey—Koopmans—Cass model of optimal growth, that it outperforms alternative criterions used in the literature.