Determining the number of factors in approximate factor models by twice K-fold cross validation

Jie Wei and Hui Chen

Economics Letters, 2020, vol. 191, issue C

Abstract: We propose a data driven determination method of the number of factors by cross validation (CV) in approximate factor models. A K-fold CV is applied along each of the two directions (individual and time) of a panel dataset. We prove the consistency of the proposed twice K-fold CV under mild conditions. Monte Carlo simulations demonstrate superior and robust performance of our selection method in comparison with existing approaches, especially at small panels with moderate units or time lengths. An empirical application to identify factor numbers in the UK is provided.

Keywords: Approximate factor models; K-fold cross validation; Consistency; Finite sample performance (search for similar items in EconPapers)
JEL-codes: C52 C55 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:191:y:2020:i:c:s0165176520301191

DOI: 10.1016/j.econlet.2020.109149

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