Error-correction factor models for high-dimensional cointegrated time series

Yundong Tu, Qiwei Yao and Rongmao Zhang

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Cointegration inferences often rely on a correct specification for the short-run dynamic vector autoregression. However, this specification is unknown, a priori. A lag length that is too small leads to an erroneous inference as a result of the misspecification. In contrast, using too many lags leads to a dramatic increase in the number of parameters, especially when the dimension of the time series is high. In this paper, we develop a new methodology which adds an error-correction term for the long-run equilibrium to a latent factor model in order to model the short-run dynamic relationship. The inferences use the eigenanalysis-based methods to estimate the cointegration and latent factor process. The proposed error-correction factor model does not require an explicit specification of the short-run dynamics, and is particularly effective for high-dimensional cases, in which the standard error-correction suffers from overparametrization. In addition, the model improves the predictive performance of the pure factor model. The asymptotic properties of the proposed methods are established when the dimension of the time series is either fixed or diverging slowly as the length of the time series goes to infinity. Lastly, the performance of the model is evaluated using both simulated and real data sets.

Keywords: cointegration; eigenanalysis; factor models; nonstationary processes; vector time series (search for similar items in EconPapers)
JEL-codes: C1 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2020-07-01
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Published in Statistica Sinica, 1, July, 2020, 30(3), pp. 1463 - 1484. ISSN: 1017-0405

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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:106994

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