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Improved penalization for determining the number of factors in approximate factor models

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  • Alessi, Lucia
  • Barigozzi, Matteo
  • Capasso, Marco

Abstract

The procedure proposed by Bai and Ng (2002) for identifying the number of factors in static factor models is revisited. In order to improve its performance, we introduce a tuning multiplicative constant in the penalty, an idea that was proposed by Hallin and Liska (2007) in the context of dynamic factor models. Simulations show that our method in general delivers more reliable estimates, in particular in the case of large idiosyncratic disturbances.

Suggested Citation

  • Alessi, Lucia & Barigozzi, Matteo & Capasso, Marco, 2010. "Improved penalization for determining the number of factors in approximate factor models," Statistics & Probability Letters, Elsevier, vol. 80(23-24), pages 1806-1813, December.
    • Handle: RePEc:eee:stapro:v:80:y:2010:i:23-24:p:1806-1813
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    References listed on IDEAS

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    1. Jushan Bai & Serena Ng, 2002. "Determining the Number of Factors in Approximate Factor Models," Econometrica, Econometric Society, vol. 70(1), pages 191-221, January.
    2. Pan, Jiazhu & Yao, Qiwei, 2008. "Modelling multiple time series via common factors," LSE Research Online Documents on Economics 22876, London School of Economics and Political Science, LSE Library.
    3. Mario Forni & Marc Hallin & Marco Lippi & Lucrezia Reichlin, 2000. "The Generalized Dynamic-Factor Model: Identification And Estimation," The Review of Economics and Statistics, MIT Press, vol. 82(4), pages 540-554, November.
    4. Engle, Robert F. & Ng, Victor K. & Rothschild, Michael, 1990. "Asset pricing with a factor-arch covariance structure : Empirical estimates for treasury bills," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 213-237.
    5. James H. Stock & Mark W. Watson, 2005. "Implications of Dynamic Factor Models for VAR Analysis," NBER Working Papers 11467, National Bureau of Economic Research, Inc.
    6. Hallin, Marc & Liska, Roman, 2007. "Determining the Number of Factors in the General Dynamic Factor Model," Journal of the American Statistical Association, American Statistical Association, vol. 102, pages 603-617, June.
    7. Jiazhu Pan & Qiwei Yao, 2008. "Modelling multiple time series via common factors," Biometrika, Biometrika Trust, vol. 95(2), pages 365-379.
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