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Constrained principal components estimation of large approximate factor models

Author

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  • Rachida Ouysse

    () (School of Economics, UNSW Business School, UNSW)

Abstract

Principal components (PC) are fundamentally feasible for the estimation of large factor models because consistency can be achieved for any path of the panel dimensions. The PC method is however inefficient under cross-sectional dependence with unknown structure. The approximate factor model of Chamberlain and Rothschild [1983] imposes a bound on the amount of dependence in the error term. This article proposes a constrained principal components (Cn-PC) estimator that incorporates this restriction as external information in the PC analysis of the data. This estimator is computationally tractable. It doesn't require estimating large covariance matrices, and is obtained as PC of a regularized form of the data covariance matrix. The paper develops a convergence rate for the factor estimates and establishes asymptotic normality. In a Monte Carlo study, we find that the Cn-PC estimators have good small sample properties in terms of estimation and forecasting performances when compared to the regular PC and to the generalized PC method (Choi [2012]).

Suggested Citation

  • Rachida Ouysse, 2017. "Constrained principal components estimation of large approximate factor models," Discussion Papers 2017-12, School of Economics, The University of New South Wales.
    • Handle: RePEc:swe:wpaper:2017-12
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    File URL: http://research.economics.unsw.edu.au/RePEc/papers/2017-12.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    High dimensionality; unknown factors; principal components; cross-sectional correlation; shrinkage regression; out-of-sample forecasting;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C55 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Large Data Sets: Modeling and Analysis

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