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A Quasi–Maximum Likelihood Approach for Large, Approximate Dynamic Factor Models

  • Catherine Doz

    (Paris School of Economics and University Paris 1 Panthéon-Sorbonne)

  • Domenico Giannone

    (Université libre de Bruxelles, ECARES, and CEPR)

  • Lucrezia Reichlin

    (London Business School and CEPR)

Is maximum likelihood suitable for factor models in large cross-sections of time series? We answer this question from both an asymptotic and an empirical perspective. We show that estimates of the common factors based on maximum likelihood are consistent for the size of the cross-section (n) and the sample size (T), going to infinity along any path, and that maximum likelihood is viable for n large. The estimator is robust to misspecification of cross-sectional and time series correlation of the idiosyncratic components. In practice, the estimator can be easily implemented using the Kalman smoother and the EM algorithm as in traditional factor analysis. © 2012 The President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Article provided by MIT Press in its journal Review of Economics and Statistics.

Volume (Year): 94 (2012)
Issue (Month): 4 (November)
Pages: 1014-1024

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Handle: RePEc:tpr:restat:v:94:y:2012:i:4:p:1014-1024
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