Testing for structural stability of factor augmented forecasting models

Valentina Corradi and Norman Swanson ()

Journal of Econometrics, 2014, vol. 182, issue 1, 100-118

Abstract: Mild factor loading instability, particularly if sufficiently independent across the different constituent variables, does not affect the estimation of the number of factors, nor subsequent estimation of the factors themselves (see e.g. Stock and Watson (2009)). This result does not hold in the presence of large common breaks in the factor loadings, however. In this case, information criteria overestimate the number of breaks. Additionally, estimated factors are no longer consistent estimators of “true” factors. Hence, various recent research papers in the diffusion index literature focus on testing the constancy of factor loadings. However, forecast failure of factor augmented models can be due to either factor loading instability, regression coefficient instability, or both. To address this issue, we develop a test for the joint hypothesis of structural stability of both factor loadings and factor augmented forecasting model regression coefficients. Our proposed test statistic has a chi-squared limiting distribution, and we are able to establish the first order validity of (block) bootstrap critical values. Empirical evidence is also presented for 11 US macroeconomic indicators.

Keywords: Diffusion index; Factor loading stability; Forecast failure; Forecast stability; Regression coefficients stability (search for similar items in EconPapers)
JEL-codes: C12 C22 C53 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (48)

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Working Paper: Testing for Structural Stability of Factor Augmented Forecasting Models (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:182:y:2014:i:1:p:100-118

DOI: 10.1016/j.jeconom.2014.04.011

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