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Consistent factor estimation in dynamic factor models with structural instability

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  • Bates, Brandon J.
  • Plagborg-Møller, Mikkel
  • Stock, James H.
  • Watson, Mark W.

Abstract

This paper considers the estimation of approximate dynamic factor models when there is temporal instability in the factor loadings. We characterize the type and magnitude of instabilities under which the principal components estimator of the factors is consistent and find that these instabilities can be larger than earlier theoretical calculations suggest. We also discuss implications of our results for the robustness of regressions based on the estimated factors and of estimates of the number of factors in the presence of parameter instability. Simulations calibrated to an empirical application indicate that instability in the factor loadings has a limited impact on estimation of the factor space and diffusion index forecasting, whereas estimation of the number of factors is more substantially affected.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 177 (2013)
Issue (Month): 2 ()
Pages: 289-304

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Handle: RePEc:eee:econom:v:177:y:2013:i:2:p:289-304

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Web page: http://www.elsevier.com/locate/jeconom

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Cited by:
  1. Liang Chen & Juan Dolado & Jesus Gonzalo, 2013. "Detecting Big Structural Breaks in Large Factor Models," Economics Series Working Papers 677, University of Oxford, Department of Economics.
  2. Cheng, Xu & Liao, Zhipeng & Schorfheide, Frank, 2013. "Shrinkage estimation of high-dimensional factor models with structural instabilities," Working Papers 14-4, Federal Reserve Bank of Philadelphia.
  3. Xu Cheng & Zhipeng Liao & Frank Schorfheide, 2014. "Shrinkage Estimation of High-Dimensional Factor Models with Structural Instabilities," NBER Working Papers 19792, National Bureau of Economic Research, Inc.

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