Dynamic Factor Models, Cointegration, and Error Correction Mechanisms

Matteo Barigozzi, Marco Lippi and Matteo Luciani

No 2016-018, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: The paper studies Non-Stationary Dynamic Factor Models such that: (1) the factors Ft are I(1) and singular, i.e. Ft has dimension r and is driven by a q-dimensional white noise, the common shocks, with q < r, and (2) the idiosyncratic components are I(1). We show that Ft is driven by r-c permanent shocks, where c is the cointegration rank of Ft, and q - (r - c) < c transitory shocks, thus the same result as in the non-singular case for the permanent shocks but not for the transitory shocks. Our main result is obtained by combining the classic Granger Representation Theorem with recent results by Anderson and Deistler on singular stochastic vectors: if (1 - L)Ft is singular and has rational spectral density then, for generic values of the parameters, Ft has an autoregressive representation with a finite-degree matrix polynomial fulfilling the restrictions of a Vector Error Correction Mechanism with c error terms. This result is the basis for consistent estimation of Non-Stationary Dynamic Factor Models. The relationship between cointegration of the factors and cointegration of the observable variables is also discussed.

Keywords: Cointegration for singular vectors; Dynamic Factor Models for I(1) variables; Granger Representation Theorem for singular vectors (search for similar items in EconPapers)
JEL-codes: C01 E00 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2016-02-16
New Economics Papers: this item is included in nep-ets and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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http://www.federalreserve.gov/econresdata/feds/2016/files/2016018pap.pdf DOI (application/pdf)
http://dx.doi.org/10.17016/FEDS.2016.018

Related works:
Working Paper: Dynamic Factor Models, Cointegration and Error Correction Mechanisms (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2016-18

DOI: 10.17016/FEDS.2016.018

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