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Another look into the factor model black box: factor interpretation and structural (in)stability

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  • Thomas Despois

    (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PSE - Paris School of Economics - ENPC - École des Ponts ParisTech - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique - EHESS - École des hautes études en sciences sociales - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

  • Catherine Doz

    () (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PSE - Paris School of Economics - ENPC - École des Ponts ParisTech - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique - EHESS - École des hautes études en sciences sociales - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

Abstract

This paper considers two families of methods allowing to get interpretable factors without imposing their interpretation a priori: factor rotations and sparse PCA. Monte Carlo simulations show their performance in recovering the correct factor structure. In an empirical application with a large U.S. macroeconomic dataset, they recover the same factor structure, offering a clear economic interpretation. This factor representation seems more natural and informative than competitors, offering new lens to disentangle the driving forces within a factor model. In particular, the structural instability appears to be more limited, and of different nature than what was previously found.

Suggested Citation

  • Thomas Despois & Catherine Doz, 2020. "Another look into the factor model black box: factor interpretation and structural (in)stability," PSE Working Papers halshs-02235543, HAL.
  • Handle: RePEc:hal:psewpa:halshs-02235543
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-02235543v2
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    References listed on IDEAS

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    Keywords

    dynamic factor models; factor rotations; sparse PCA; structural break;
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