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Determining the Number of Factors in the General Dynamic Factor Model

Marc Hallin and Roman Liška
Journal of the American Statistical Association
Vol. 102, No. 478 (Jun., 2007), pp. 603-617
Stable URL: http://www.jstor.org/stable/27639890
Page Count: 15
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Determining the Number of Factors in the General Dynamic Factor Model
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Abstract

This article develops an information criterion for determining the number q of common shocks in the general dynamic factor model developed by Forni et al., as opposed to the restricted dynamic model considered by Bai and Ng and by Amengual and Watson. Our criterion is based on the fact that this number q is also the number of diverging eigenvalues of the spectral density matrix of the observations as the number n of series goes to infinity. We provide sufficient conditions for consistency of the criterion for large n and T (where T is the series length). We show how the method can be implemented and provide simulations and empirics illustrating its very good finite-sample performance. Application to real data adds a new empirical facet to an ongoing debate on the number of factors driving the U.S. economy.

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