Avoiding jumps in the rotation matrix of time-varying factor models

Ying Lun Cheung

Finance Research Letters, 2024, vol. 67, issue PB

Abstract: Time-varying factor models have gained much popularity in recent years. However, the newly developed local estimator is susceptible to a time-varying rotation matrix that may exhibit jumps. This letter proposes a simple method to avoid the jumps. We show by simulations that the proposed procedure can effectively eliminate jumps in the rotation matrix, leading to a substantially lower mean-square forecasting error.

Keywords: Approximate factor models; Local PCA; Rotations; Time-varying coefficients (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:67:y:2024:i:pb:s1544612324008997

DOI: 10.1016/j.frl.2024.105869

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