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The generalised dynamic factor model: identification and estimation

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  • Mario Forni
  • Marc Hallin
  • Lucrezia Reichlin
  • Marco Lippi

Abstract

This paper analyzes identification conditions, and proposes an estimator, for a dynamic factor model where the idiosyncratic components are allowed to be mutually non-orthogonal. This model, which we call the generalized dynamic factor model, is novel to the literature, and generalizes the static approximate factor model of Chamberlain and Rothschild (1983), as well as the exact factor model à la Sargent and Sims (1977). We propose an estimator of the common components and prove convergence as both time and cross-sectional size go to infinity at appropriate rates. Simulations yield encouraging results in small samples. We use our model to construct an index of the state of the economy for the European currency area. Such an index is defined as the common component of real GDP within a model including several macroeconomic variables for each European country.

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Bibliographic Info

Paper provided by ULB -- Universite Libre de Bruxelles in its series ULB Institutional Repository with number 2013/10143.

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Date of creation: 01 Nov 2000
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Publication status: Published in: The Review of Economics and Statistics (2000) v.82 n° 4,p.540-554
Handle: RePEc:ulb:ulbeco:2013/10143

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References

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  1. Forni, Mario & Reichlin, Lucrezia, 1996. "Dynamic Common Factors in Large Cross-Sections," Empirical Economics, Springer, Springer, vol. 21(1), pages 27-42.
  2. James H. Stock & Mark W. Watson, 1989. "New Indexes of Coincident and Leading Economic Indicators," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 351-409 National Bureau of Economic Research, Inc.
  3. Forni, Mario & Lippi, Marco, 2000. "The Generalized Dynamic Factor Model: Representation Theory," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2509, C.E.P.R. Discussion Papers.
  4. Arthur F. Burns & Wesley C. Mitchell, 1946. "Measuring Business Cycles," NBER Books, National Bureau of Economic Research, Inc, number burn46-1, July.
  5. Forni, Mario & Reichlin, Lucrezia, 1997. "National Policies and Local Economies: Europe and the United States," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1632, C.E.P.R. Discussion Papers.
  6. Forni, Mario & Reichlin, Lucrezia, 1998. "Let's Get Real: A Factor Analytical Approach to Disaggregated Business Cycle Dynamics," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 65(3), pages 453-73, July.
  7. Chamberlain, Gary, 1983. "Funds, Factors, and Diversification in Arbitrage Pricing Models," Econometrica, Econometric Society, Econometric Society, vol. 51(5), pages 1305-23, September.
  8. Forni, Mario & Lippi, Marco, 1997. "Aggregation and the Microfoundations of Dynamic Macroeconomics," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780198288008, October.
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