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Estimation and Inference for High Dimensional Factor Model with Regime Switching

Urga, G. ORCID: 0000-0002-6742-7370 & Wang, F. (2024). Estimation and Inference for High Dimensional Factor Model with Regime Switching. Journal of Econometrics, 241(2), article number 105752. doi: 10.1016/j.jeconom.2024.105752


This paper proposes maximum (quasi)likelihood estimation for high dimensional factor models with regime switching in the loadings. The model parameters are estimated jointly by the EM (expectation maximization) algorithm, which in the current context only requires iteratively calculating regime probabilities and principal components of the weighted sample covariance matrix. When regime dynamics are taken into account, smoothed regime probabilities are calculated using a recursive algorithm. Consistency, convergence rates and limit distributions of the estimated loadings and the estimated factors are established under weak cross-sectional and temporal dependence as well as heteroscedasticity. It is worth noting that due to high dimension, regime switching can be identiÖed consistently after the switching point with only one observation. Simulation results show good performance of the proposed method. An application to the FRED-MD dataset illustrates the potential of the proposed method for detection of business cycle turning points.

Publication Type: Article
Additional Information: © 2024. This manuscript version is made available under the CC-BY-NC-ND 4.0 license
Publisher Keywords: Factor model, Regime switching, Maximum likelihood, High dimension, EM algorithm, Turning points
Subjects: H Social Sciences > HG Finance
Q Science > QA Mathematics
Departments: Bayes Business School > Finance
SWORD Depositor:
[thumbnail of Estimation and inference for high dimensional factor model with regime switching.pdf] Text - Accepted Version
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