City Research Online

Abstract

We propose a simple but effective estimation procedure to extract the level and the volatility dynamics of a latent macroeconomic factor from a panel of observable indicators. Our approach is based on a multivariate conditionally heteroskedastic exact factor model that can take into account the heteroskedasticity feature shown by most macroeconomic variables and relies on an iterated Kalman filter procedure. In simulations we show the unbiasedness of the proposed estimator and its superiority to different approaches introduced in the literature. Simulation results are confirmed in applications to real inflation data with the goal of forecasting long-term bond risk premia. Moreover, we find that the extracted level and conditional variance of the latent factor for inflation are strongly related to NBER business cycles.

Publication Type:	Article
Additional Information:	This is an Accepted Manuscript of an article published by Taylor & Francis in Econometric Reviews, available online: http://wwww.tandfonline.com/10.1080/07474938.2013.833809
Publisher Keywords:	Business cycles, Exact factor model, Forecasting bond risk premia, Heteroskedasticity, Inflation measures, Kalman filter, Macroeconomic variables
Subjects:	H Social Sciences > HB Economic Theory
Departments:	School of Policy & Global Affairs > Economics
SWORD Depositor:	Symplectic Administrator

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