Joint Modelling and Estimation of Global and Local Cross-Sectional Dependence in Large Panels

Siem Jan Koopman, Julia Schaumburg and Quint Wiersma
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Julia Schaumburg: Vrije Universiteit Amsterdam
Quint Wiersma: Vrije Universiteit Amsterdam

No 21-008/III, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We propose a new unified approach to identifying and estimating spatio-temporal dependence structures in large panels. The model accommodates global cross-sectional dependence due to global dynamic factors as well as local cross-sectional dependence, which may arise from local network structures. Model selection, filtering of the dynamic factors, and estimation are carried out iteratively using a new algorithm that combines the Expectation-Maximization algorithm with coordinate descent and gradient descent, allowing us to efficiently maximize an l1- and l2-penalized state space likelihood function. A Monte Carlo simulation study illustrates the good performance of the algorithm in terms of determining the presence and magnitude of global and/or local cross-sectional dependence. In an empirical application, we investigate monthly US interest rate data on 15 maturities over almost 40 years. We find that besides a changing number of global dynamic factors, there is heterogeneous local dependence among neighboring maturities. Taking this heterogeneity into account substantially improves out-of-sample forecasting performance.

Keywords: high-dimensional factor model; Lasso; spatial error model; yield curve (search for similar items in EconPapers)
JEL-codes: C32 C33 C38 (search for similar items in EconPapers)
Date: 2021-01-21
New Economics Papers: this item is included in nep-ecm
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20210008

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