A SUGGESTION FOR A DYNAMIC MULTIFACTOR MODEL (DMFM)

Heather Gibson, Stephen Hall and George Tavlas

Macroeconomic Dynamics, 2022, vol. 26, issue 6, 1423-1443

Abstract: We provide a new way of deriving a number of dynamic unobserved factors from a set of variables. We show how standard principal components may be expressed in state space form and estimated using the Kalman filter. To illustrate our procedure, we perform two exercises. First, we use it to estimate a measure of the current account imbalances among northern and southern euro area countries that developed during the period leading up to the outbreak of the euro area crisis, before looking at adjustment in the post-crisis period. Second, we show how these dynamic factors can improve forecasting of the euro exchange rate.

Date: 2022
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Working Paper: A Suggestion for a Dynamic Multi Factor Model (DMFM) (2020)
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