Testing for time-varying loadings in dynamic factor models

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Abstract: In this paper we develop a test for time-varying factor loadings in factor models. The test is simple to compute and is constructed from estimated factors and residuals using the principal components estimator. The hypothesis is tested by regressing the squared residuals on the squared factors. The squared correlation coefficient times the sample size has a limiting chi-squared distribution. The test can be made robust to serial correlation in the idiosyncratic errors. We find evidence for factor loadings variance in over half of the variables in a dataset for the US economy, while there is evidence of time-varying loadings on the risk factors underlying portfolio returns for around 80% of the portfolios.
Original languageEnglish
Place of PublicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages46
StatePublished - 14 Jun 2017
SeriesCREATES Research Papers
Number2017-22

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