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Testing for structural breaks in dynamic factor models

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  • Breitung, Jörg
  • Eickmeier, Sandra

Abstract

From time to time, economies undergo far-reaching structural changes. In this paper we investigate the consequences of structural breaks in the factor loadings for the specification and estimation of factor models based on principal components and suggest test procedures for structural breaks. It is shown that structural breaks severely inflate the number of factors identified by the usual information criteria. Based on the strict factor model the hypothesis of a structural break is tested by using Likelihood-Ratio, Lagrange-Multiplier and Wald statistics. The LM test which is shown to perform best in our Monte Carlo simulations, is generalized to factor models where the common factors and idiosyncratic components are serially correlated. We also apply the suggested test procedure to a US dataset used in Stock and Watson (2005) and a euro-area dataset described in Altissimo et al. (2007). We find evidence that the beginning of the so-called Great Moderation in the US as well as the Maastricht treaty and the handover of monetary policy from the European national central banks to the ECB coincide with structural breaks in the factor loadings. Ignoring these breaks may yield misleading results if the empirical analysis focuses on the interpretation of common factors or on the transmission of common shocks to the variables of interest. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 1: Economic Studies with number 2009,05.

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Date of creation: 2009
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Handle: RePEc:zbw:bubdp1:7574

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Keywords: Dynamic factor models; structural breaks; number of factors; Great Moderation; EMU;

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Citations

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Cited by:
  1. 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.
  2. Liang Chen & Juan José Dolado & Jesús Gonzalo, 2011. "Detecting big structural breaks in large factor models," Economics Working Papers we1141, Universidad Carlos III, Departamento de Economía.
  3. 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.
  4. 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.
  5. Valentina Corradi & Norman Swanson, 2013. "Testing for Structural Stability of Factor Augmented Forecasting Models," Departmental Working Papers 201314, Rutgers University, Department of Economics.
  6. Bates, Brandon J. & Plagborg-Møller, Mikkel & Stock, James H. & Watson, Mark W., 2013. "Consistent factor estimation in dynamic factor models with structural instability," Journal of Econometrics, Elsevier, vol. 177(2), pages 289-304.
  7. Matteo Luciani & Antoniomaria Conti & Matteo Barigozzi, 2013. "Do Euro Area Countries Respond Asymmetrically to the Common Monetary Policy?," ULB Institutional Repository 2013/153330, ULB -- Universite Libre de Bruxelles.
  8. Matteo Barigozzi & Antonio M. Conti & Matteo Luciani, 2013. "Do euro area countries respond asymmetrically to the common monetary policy?," Temi di discussione (Economic working papers) 923, Bank of Italy, Economic Research and International Relations Area.
  9. Chen, Liang, 2012. "Identifying observed factors in approximate factor models: estimation and hypothesis testing," MPRA Paper 37514, University Library of Munich, Germany.
  10. YAMAMOTO, Yohei & TANAKA, Shinya, 2013. "Testing for Factor Loading Structural Change under Common Breaks," Discussion Papers 2013-17, Graduate School of Economics, Hitotsubashi University.
  11. Johannes Tang Kristensen, 2012. "Factor-Based Forecasting in the Presence of Outliers: Are Factors Better Selected and Estimated by the Median than by The Mean?," CREATES Research Papers 2012-28, School of Economics and Management, University of Aarhus.
  12. 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.

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