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Smooth Dynamic Factor Analysis with Application to the U.S. Term Structure of Interest RatesBorus JungbackerVU University Amsterdam - Department of Economics Siem Jan KoopmanVU University Amsterdam; Tinbergen Institute Michel Van der WelErasmus University Rotterdam; CREATES; ERIM; Tinbergen Institute May 17, 2012 Journal of Applied Econometrics (Forthcoming) CREATES Research Paper 2009-39 Tinbergen Institute Discussion Paper 09-041/4 Abstract: We consider the dynamic factor model and show how smoothness restrictions can be imposed on factor loadings by using cubic spline functions. We develop statistical procedures based on Wald, Lagrange multiplier and likelihood ratio tests for this purpose. The methodology is illustrated by analyzing a newly updated monthly time series panel of U.S. term structure of interest rates. Dynamic factor models with and without smooth loadings are compared with dynamic models based on Nelson-Siegel and cubic spline yield curves. We conclude that smoothness restrictions on factor loadings are supported by the interest rate data and can lead to more accurate forecasts.
Number of Pages in PDF File: 56 Keywords: Fama-Bliss data set, Kalman filter, Maximum likelihood, Yield curve JEL Classification: C32, C51, E43 Accepted Paper SeriesDate posted: May 12, 2009 ; Last revised: November 20, 2012Suggested CitationContact Information
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