TY - JOUR
T1 - Selecting the Correct Number of Factors in Approximate Factor Models
T2 - The Large Panel Case With Group Bridge Estimators
AU - Caner, Mehmet
AU - Han, Xu
PY - 2014/7
Y1 - 2014/7
N2 - This article proposes a group bridge estimator to select the correct number of factors in approximate factor models. It contributes to the literature on shrinkage estimation and factor models by extending the conventional bridge estimator from a single equation to a large panel context. The proposed estimator can consistently estimate the factor loadings of relevant factors and shrink the loadings of irrelevant factors to zero with a probability approaching one. Hence, it provides a consistent estimate for the number of factors. We also propose an algorithm for the new estimator; Monte Carlo experiments show that our algorithm converges reasonably fast and that our estimator has very good performance in small samples. An empirical example is also presented based on a commonly used U.S. macroeconomic dataset.
AB - This article proposes a group bridge estimator to select the correct number of factors in approximate factor models. It contributes to the literature on shrinkage estimation and factor models by extending the conventional bridge estimator from a single equation to a large panel context. The proposed estimator can consistently estimate the factor loadings of relevant factors and shrink the loadings of irrelevant factors to zero with a probability approaching one. Hence, it provides a consistent estimate for the number of factors. We also propose an algorithm for the new estimator; Monte Carlo experiments show that our algorithm converges reasonably fast and that our estimator has very good performance in small samples. An empirical example is also presented based on a commonly used U.S. macroeconomic dataset.
KW - Bridge estimation
KW - Common factors
KW - Selection consistency
UR - http://www.scopus.com/inward/record.url?scp=84925934601&partnerID=8YFLogxK
UR - https://www.scopus.com/record/pubmetrics.uri?eid=2-s2.0-84925934601&origin=recordpage
U2 - 10.1080/07350015.2014.880349
DO - 10.1080/07350015.2014.880349
M3 - RGC 21 - Publication in refereed journal
SN - 0735-0015
VL - 32
SP - 359
EP - 374
JO - Journal of Business & Economic Statistics
JF - Journal of Business & Economic Statistics
IS - 3
ER -