Disentangling Structural Breaks in High Dimensional Factor Models

Bonsoo Koo, Benjamin Wong and Ze-Yu Zhong

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

Abstract: We disentangle structural breaks in dynamic factor models by establishing a projection based equivalent representation theorem which decomposes any break into a rotational change and orthogonal shift. Our decomposition leads to the natural interpretation of these changes as a change in the factor variance and loadings respectively, which allows us to formulate two separate tests to differentiate between these two cases, unlike the pre-existing literature at large. We derive the asymptotic distributions of the two tests, and demonstrate their good finite sample performance. We apply the tests to the FRED-MD dataset focusing on the Great Moderation and Global Financial Crisis as candidate breaks, and find evidence that the Great Moderation may be better characterised as a break in the factor variance as opposed to a break in the loadings, whereas the Global Financial Crisis is a break in both. Our empirical results highlight how distinguishing between the breaks can nuance the interpretation attributed to them by existing methods.

Keywords: factor space; structural instability; breaks; principal components; dynamic factor models (search for similar items in EconPapers)
JEL-codes: C12 C38 C55 E37 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2023-03
New Economics Papers: this item is included in nep-ecm and nep-ets
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Working Paper: Disentangling Structural Breaks in High Dimensional Factor Models (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:een:camaaa:2023-15

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