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Implications of Dynamic Factor Models for VAR Analysis

Author

Listed:
  • James H. James

    (Harvard University)

  • Mark W. Watson

    (Princeton University)

Abstract

This paper considers VAR models incorporating many time series that interact through a few dynamic factors. Several econometric issues are addressed including estimation of the number of dynamic factors and tests for the factor restrictions imposed on the VAR. Structural VAR identification based on timing restrictions, long run restrictions, and restrictions on factor loadings are discussed and practical computational methods suggested. Empirical analysis using U.S. data suggest several (7) dynamic factors, rejection of the exact dynamic factor model but support for an approximate factor model, and sensible results for a SVAR that identifies money policy shocks using timing restrictions.

Suggested Citation

  • James H. James & Mark W. Watson, 2005. "Implications of Dynamic Factor Models for VAR Analysis," Working Papers 2005-2, Princeton University. Economics Department..
    • Handle: RePEc:pri:econom:2005-2
    as

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    File URL: http://www.princeton.edu/~mwatson/papers/favar.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    VAR; factor models; Structural VAR;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications

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