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TESTS FOR PARAMETER INSTABILITY IN DYNAMIC FACTOR MODELS

Published online by Cambridge University Press:  15 September 2014

Xu Han  and
Atsushi Inoue
Xu Han*
Affiliation:
City University of Hong Kong
Atsushi Inoue*
Affiliation:
Vanderbilt University and Tohoku University
*
*Address correspondence to Xu Han, Department of Economics and Finance, City University of Hong Kong, Kowloon, Hong Kong SAR; e-mail: [email protected] or to Atsushi Inoue, Department of Economics, Vanderbilt University, Nashville, TN 37235, USA; email: [email protected].
*Address correspondence to Xu Han, Department of Economics and Finance, City University of Hong Kong, Kowloon, Hong Kong SAR; e-mail: [email protected] or to Atsushi Inoue, Department of Economics, Vanderbilt University, Nashville, TN 37235, USA; email: [email protected].
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Abstract

In this paper, we develop tests for structural breaks of factor loadings in dynamic factor models. We focus on the joint null hypothesis that all factor loadings are constant over time. Because the number of factor loading parameters goes to infinity as the sample size grows, conventional tests cannot be used. Based on the fact that the presence of a structural change in factor loadings yields a structural change in second moments of factors obtained from the full sample principal component estimation, we reduce the infinite-dimensional problem into a finite-dimensional one and our statistic compares the pre- and postbreak subsample second moments of estimated factors. Our test is consistent under the alternative hypothesis in which a fraction of or all factor loadings have structural changes. The Monte Carlo results show that our test has good finite-sample size and power.

Type
ARTICLES
Information
Econometric Theory , Volume 31 , Issue 5 , October 2015 , pp. 1117 - 1152
Copyright
Copyright © Cambridge University Press 2014 

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