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Regularized Estimation of Structural Instability in Factor Models: The US Macroeconomy and the Great Moderation

Laurent Callot () and Johannes Kristensen ()

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: This paper shows that the parsimoniously time-varying methodology of Callot and Kristensen (2015) can be applied to factormodels.We apply this method to study macroeconomic instability in the US from 1959:1 to 2006:4 with a particular focus on the Great Moderation. Models with parsimoniously time-varying parameters are models with an unknown number of break points at unknown locations. The parameters are assumed to follow a random walk with a positive probability that an increment is exactly equal to zero so that the parameters do not vary at every point in time. The vector of increments, which is high dimensional by construction and sparse by assumption, is estimated using the Lasso. We apply this method to the estimation of static factor models and factor augmented autoregressions using a set of 190 quarterly observations of 144 US macroeconomic series from Stock andWatson (2009).We find that the parameters of both models exhibit a higher degree of instability in the period from 1970:1 to 1984:4 relative to the following 15 years. In our setting the Great Moderation appears as the gradual ending of a period of high structural instability that took place in the 1970s and early 1980s.

Keywords: Parsimoniously time-varying parameters; factor models; structural break; Lasso (search for similar items in EconPapers)
JEL-codes: C01 C13 C32 C38 E32 (search for similar items in EconPapers)
Pages: 30
Date: 2015-06-01
New Economics Papers: this item is included in nep-ecm and nep-mac
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ftp://ftp.econ.au.dk/creates/rp/15/rp15_29.pdf (application/pdf)

Related works:
Chapter: Regularized Estimation of Structural Instability in Factor Models: The US Macroeconomy and the Great Moderation (2016) Downloads
Working Paper: Regularized Estimation of Structural Instability in Factor Models: The US Macroeconomy and the Great Moderation (2015) Downloads
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