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Detecting Big Structural Breaks in Large Factor Models

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  • Liang Chen
  • Juan Dolado
  • Jesus Gonzalo

Abstract

Time invariance of factor loadings is a standard assumption in the analysis of large factor models.� Yet, this assumption may be restrictive unless parameter shifts are mild (i.e., local to zero).� In this paper we develop a new testing procedure to detect big breaks in these loadings at either known or unknown dates.� It relies upon testing for parameter breaks in a regression of one of the factors estimated by Principal Components analysis on the remaining estimated factors, where the number of factors is chosen according to Bai and Ng's (2002) information criteria.� The test fares well in terms of power relative to other recently proposed tests on this issue, and can be easily implemented to avoid forecasting failures in standard factor-augmented (FAR, FAVAR) models where the number of factors is a priori imposed on the basis of theoretical considerations.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 677.

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Date of creation: 14 Oct 2013
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Handle: RePEc:oxf:wpaper:677

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Keywords: Structural break; large factor model; factor loadings; principal components;

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Citations

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Cited by:
  1. Chen, Liang, 2012. "Identifying observed factors in approximate factor models: estimation and hypothesis testing," MPRA Paper 37514, University Library of Munich, Germany.
  2. Valentina Corradi & Norman Swanson, 2013. "Testing for Structural Stability of Factor Augmented Forecasting Models," Departmental Working Papers 201314, Rutgers University, Department of Economics.
  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.
  4. Chihwa Kao & Lorenzo Trapani & Giovanni Urga, 2012. "Testing for Breaks in Cointegrated Panels," Center for Policy Research Working Papers 135, Center for Policy Research, Maxwell School, Syracuse University.
  5. YAMAMOTO, Yohei & TANAKA, Shinya, 2013. "Testing for Factor Loading Structural Change under Common Breaks," Discussion Papers 2013-17, Graduate School of Economics, Hitotsubashi University.
  6. Xu Han & Atsushi Inoue, 2011. "Tests for Parameter Instability in Dynamic Factor Models," TERG Discussion Papers 306, Graduate School of Economics and Management, Tohoku University, revised May 2013.
  7. 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.

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