A Generalized Factor Model with Local Factors

Simon Freyaldenhoven

No 19-23, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: I extend the theory on factor models by incorporating local factors into the model. Local factors only affect an unknown subset of the observed variables. This implies a continuum of eigenvalues of the covariance matrix, as is commonly observed in applications. I derive which factors are pervasive enough to be economically important and which factors are pervasive enough to be estimable using the common principal component estimator. I then introduce a new class of estimators to determine the number of those relevant factors. Unlike existing estimators, my estimators use not only the eigenvalues of the covariance matrix, but also its eigenvectors. I find strong evidence of local factors in a large panel of US macroeconomic indicators.

Keywords: high-dimensional data; factor models; weak factors; local factors; sparsity (search for similar items in EconPapers)
JEL-codes: C38 C52 C55 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2019-04-19
New Economics Papers: this item is included in nep-ets and nep-ore
Note: Superseded by Working Paper 21-15
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: A Generalized Factor Model with Local Factors (2017)
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DOI: 10.21799/frbp.wp.2019.23

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