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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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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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Cited by:
  1. Brandon J. Bates & Mikkel Plagborg-Møller & James H. Stock & Mark W. Watson, . "Consistent factor estimation in dynamic factor models with structural instability," Working Paper 84631, Harvard University OpenScholar.
  2. 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.
  3. Chen, Liang & Dolado, Juan Jose & Gonzalo, Jesus, 2011. "Detecting big structural breaks in large factor models," MPRA Paper 31344, University Library of Munich, Germany.
  4. Corradi, Valentina & Swanson, Norman R., 2014. "Testing for structural stability of factor augmented forecasting models," Journal of Econometrics, Elsevier, Elsevier, vol. 182(1), pages 100-118.
  5. 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.
  6. 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.
  7. Chihwa Kao & Lorenzo Trapani & Giovanni Urga, 2012. "Testing for Breaks in Cointegrated Panels," Center for Policy Research Working Papers, Center for Policy Research, Maxwell School, Syracuse University 135, Center for Policy Research, Maxwell School, Syracuse University.
  8. 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.
  9. 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), Bank of Italy, Economic Research and International Relations Area 923, Bank of Italy, Economic Research and International Relations Area.
  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. Xu Han & Atsushi Inoue, 2011. "Tests for Parameter Instability in Dynamic Factor Models," TERG Discussion Papers, Graduate School of Economics and Management, Tohoku University 306, Graduate School of Economics and Management, Tohoku University, revised May 2013.
  12. Lorenzo Trapani, 2014. "Comments on: Extensions of some classical methods in change point analysis," TEST: An Official Journal of the Spanish Society of Statistics and Operations Research, Springer, Springer, vol. 23(2), pages 283-286, June.
  13. Chen, Liang, 2012. "Identifying observed factors in approximate factor models: estimation and hypothesis testing," MPRA Paper 37514, University Library of Munich, Germany.

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