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Estimation of a Dynamic Multilevel Factor Model with possible long-range dependence

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  • Ergemen, Yunus Emre
  • Rodríguez Caballero, Carlos Vladimir

Abstract

A dynamic multilevel factor model with possible stochastic time trends is proposed. In the model, long-range dependence and short memory dynamics are allowed in global and regional common factors as well as model innovations. Estimation of global and regional common factors is performed on the prewhitened series, for which the prewhitening parameter is estimated semiparametrically from the cross-sectional and regional average of the observable series. Employing canonical correlation analysis and a sequential least-squares algorithm on the prewhitened series, the resulting multilevel factor estimates have a centered asymptotic normal distribution. Selection of the number of global and regional factors is also discussed. Estimates are found to have good small-sample performance via Monte Carlo simulations. The method is then applied to the Nord Pool electricity market for the analysis of price comovements among different regions within the power grid. The global factor is identified to be the system price, and fractional cointegration relationships are found between regional prices and the system price.

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  • Ergemen, Yunus Emre & Rodríguez Caballero, Carlos Vladimir, 2017. "Estimation of a Dynamic Multilevel Factor Model with possible long-range dependence," DES - Working Papers. Statistics and Econometrics. WS 24614, Universidad Carlos III de Madrid. Departamento de Estadística.
    • Handle: RePEc:cte:wsrepe:24614
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    1. Rodríguez-Caballero, Carlos Vladimir & Caporin, Massimiliano, 2019. "A multilevel factor approach for the analysis of CDS commonality and risk contribution," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 63(C).
    2. Camacho, Maximo & Lopez-Buenache, German, 2023. "Factor models for large and incomplete data sets with unknown group structure," International Journal of Forecasting, Elsevier, vol. 39(3), pages 1205-1220.

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