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Changes in the Factor Structure of the U.S. Economy: Permanent Breaks or Business Cycle Regimes?

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  • Luke Hartigan

    (School of Economics, UNSW Business School, UNSW)

Abstract

The factor structure of the U.S. economy appears to change over time. Unlike previous studies which suggest this is due to permanent structural breaks in factor loadings, I argue instead that the volatility and persistence of factor processes undergo recurring changes related to the business cycle. To capture this, I develop a two-step Markov-switching static factor estimation procedure and apply it to a well-studied U.S. macroeconomic data set. I find strong support for Markov-switching in the factors processes, with switching variances being most dominant. Conditional on Markov-switching factor processes, tests for regime-dependent factor loadings show only moderate evidence of change. Overall, the results support regime-dependent factor processes as the main explanation for the diverging number of estimated factors in empirical applications and challenge the global linearity assumption implicit in large dimensional factor models of the U.S. economy.

Suggested Citation

  • Luke Hartigan, 2015. "Changes in the Factor Structure of the U.S. Economy: Permanent Breaks or Business Cycle Regimes?," Discussion Papers 2015-17, School of Economics, The University of New South Wales.
    • Handle: RePEc:swe:wpaper:2015-17
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    File URL: http://research.economics.unsw.edu.au/RePEc/papers/2015-17.pdf
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    Cited by:

    1. Aslanidis, Nektarios & Hartigan, Luke, 2016. "Is the Assumption of Linearity in Factor Models too Strong in Practice?," Working Papers 2072/261531, Universitat Rovira i Virgili, Department of Economics.
    2. Aslanidis, Nektarios & Hartigan, Luke, 2021. "Is the assumption of constant factor loadings too strong in practice?," Economic Modelling, Elsevier, vol. 98(C), pages 100-108.

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    More about this item

    Keywords

    Approximate Factor Model; Large Data Sets; Markov Switching Model; Structural Breaks;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C55 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Large Data Sets: Modeling and Analysis
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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