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Regularized Estimation of Structural Instability in Factor Models: The US Macroeconomy and the Great Moderation

Author

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  • Laurent Callot

    (VU University Amsterdam, the Netherlands)

  • Johannes Tang Kristensen

    (University of Southern Denmark, Denmark)

Abstract

This paper shows that the parsimoniously time-varying methodology of Callot and Kristensen (2015) can be applied to factor models. We apply this method to study macroeconomic instability in the US from 1959:1 to 2006:4 with a particular focus on the Great Moderation. Models with parsimoniously time-varying parameters are models with an unknown number of break points at unknown locations. The parameters are assumed to follow a random walk with a positive probability that an increment is exactly equal to zero so that the parameters do not vary at every point in time. The vector of increments, which is high dimensional by construction and sparse by assumption, is estimated using the Lasso. We apply this method to the estimation of static factor models and factor augmented autoregressions using a set of 190 quarterly observations of 144 US macroeconomic series from Stock and Watson (2009). We find that the parameters of both models exhibit a higher degree of instability in the period from 1970:1 to 1984:4 relative to the following 15 years. In our setting the Great Moderation appears as the gradual ending of a period of high structural instability that took place in the 1970s and early 1980s.

Suggested Citation

  • Laurent Callot & Johannes Tang Kristensen, 2015. "Regularized Estimation of Structural Instability in Factor Models: The US Macroeconomy and the Great Moderation," Tinbergen Institute Discussion Papers 15-069/III, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20150069
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    References listed on IDEAS

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    More about this item

    Keywords

    Parsimoniously time-varying parameters; factor models; structural break; Lasso;
    All these keywords.

    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • 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
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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