Testing Hypotheses About the Number of Factors in Large Factor Models
Econometrica · 2009 · Volume 77 · Issue 5
Abstract
In this paper we study high-dimensional time series that have the generalized dynamic factor structure. We develop a test of the null ofk0factors against the alternative that the number of factors is larger thank0but no larger thank1>k0. Our test statistic equals maxk0<kk1(γk−γk+1)(γk+1−γk+2), where γiis theith largest eigenvalue of the smoothed periodogram estimate of the spectral density matrix of data at a prespecified frequency. We describe the asymptotic distribution of the statistic, as the dimensionality and the number of observations rise, as a function of the Tracy–Widom distribution and tabulate the critical values of the test. As an application, we test different hypotheses about the number of dynamic factors in macroeconomic time series and about the number of dynamic factors driving excess stock returns.
Keywords
Generalized dynamic factor model, approximate factor model, number of factors, hypothesis test, Tracy–Widom distribution
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