Consistent factor estimation in dynamic factor models with structural instability

Citation:

Bates, Brandon J., Mikkel Plagborg-Møller, James H. Stock, and Mark W. Watson. 2013. “Consistent factor estimation in dynamic factor models with structural instability.” Journal of Econometrics 177 (2): 289-304.

Abstract:

This paper considers the estimation of approximate dynamic factor models when there is temporal instability in the factor loadings. We characterize the type and magnitude of instabilities under which the principal components estimator of the factors is consistent and find that these instabilities can be larger than earlier theoretical calculations suggest. We also discuss implications of our results for the robustness of regressions based on the estimated factors and of estimates of the number of factors in the presence of parameter instability. Simulations calibrated to an empirical application indicate that instability in the factor loadings has a limited impact on estimation of the factor space and diffusion index forecasting, whereas estimation of the number of factors is more substantially affected.

Notes:

Special issue of Journal of Econometrics in honor of Hashem Pesaran.

Publisher's Version

Last updated on 02/07/2019