Inference on factor structures in heterogeneous panels

Castagnetti, C., Rossi, E. & Trapani, L. (2015). Inference on factor structures in heterogeneous panels. Journal of Econometrics, 184(1), pp. 145-157. doi: 10.1016/j.jeconom.2014.08.004

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Abstract

This paper develops an estimation and testing framework for a stationary large panel model with observable regressors and unobservable common factors. We allow for slope heterogeneity and for correlation between the common factors and the regressors. We propose a two stage estimation procedure for the unobservable common factors and their loadings, based on Common Correlated Effects estimator and the Principal Component estimator. We also develop two tests for the null of no factor structure: one for the null that loadings are cross sectionally homogeneous, and one for the null that common factors are homogeneous over time. Our tests are based on using extremes of the estimated loadings and common factors. The test statistics have an asymptotic Gumbel distribution under the null, and have power versus alternatives where only one loading or common factor differs from the others. Monte Carlo evidence shows that the tests have the correct size and good power.

Item Type: Article
Additional Information: NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Econometrics. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Econometrics, Volume 184, Issue 1, January 2015, Pages 145–157, http://dx.doi.org/10.1016/j.jeconom.2014.08.004.
Uncontrolled Keywords: Large panels; CCE estimator; Principal Component estimator; Testing for factor structure; Extreme Value distribution
Subjects: H Social Sciences > HG Finance
Divisions: Cass Business School > Faculty of Finance
Related URLs:
URI: http://openaccess.city.ac.uk/id/eprint/6104

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