Unstable Diffusion Indexes: With an Application to Bond Risk Premia
54 Pages Posted: 2 Aug 2016 Last revised: 28 Jun 2019
Date Written: April 24, 2019
This paper studies the empirically relevant problem of estimation and inference in diffusion index forecasting models with structural instability. Factor model and factor augmented regression both experience a structural change with different unknown break dates. In the factor model, we estimate factors and loadings by principal components. We consider least squares estimation of the factor augmented regression and propose a break test. The empirical application uncovers instabilities in the linkages between bond risk premia and macroeconomic factors.
Keywords: Large Factor Model, Factor Augmented Regression, Structural Break, Bond Risk Premia.
JEL Classification: C12, C13, C38, C52, G12.
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