Testing for structural breaks in dynamic factor models

Jörg Breitung () and Sandra Eickmeier

No 2009,05, Discussion Paper Series 1: Economic Studies from Deutsche Bundesbank

Abstract: From time to time, economies undergo far-reaching structural changes. In this paper we investigate the consequences of structural breaks in the factor loadings for the specification and estimation of factor models based on principal components and suggest test procedures for structural breaks. It is shown that structural breaks severely inflate the number of factors identified by the usual information criteria. Based on the strict factor model the hypothesis of a structural break is tested by using Likelihood-Ratio, Lagrange-Multiplier and Wald statistics. The LM test which is shown to perform best in our Monte Carlo simulations, is generalized to factor models where the common factors and idiosyncratic components are serially correlated. We also apply the suggested test procedure to a US dataset used in Stock and Watson (2005) and a euro-area dataset described in Altissimo et al. (2007). We find evidence that the beginning of the so-called Great Moderation in the US as well as the Maastricht treaty and the handover of monetary policy from the European national central banks to the ECB coincide with structural breaks in the factor loadings. Ignoring these breaks may yield misleading results if the empirical analysis focuses on the interpretation of common factors or on the transmission of common shocks to the variables of interest.

Keywords: Dynamic factor models; structural breaks; number of factors; Great Moderation; EMU (search for similar items in EconPapers)
JEL-codes: C01 C12 C3 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-cba, nep-ecm and nep-ets
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Journal Article: Testing for structural breaks in dynamic factor models (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bubdp1:7574

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