Spanning Latent and Observable Factors
53 Pages Posted: 8 Feb 2023
Date Written: February 5, 2023
Factor analysis is a widely used tool to summarize high dimensional panel data via a small dimensional set of latent factors. Applications, particularly in finance, are often focused on observable factors with an economic interpretation. The objective of this paper is to provide a formal test for the question whether the factor spaces of latent and observable (economic) factors are equal. We derive asymptotic properties and propose a bootstrap version of the test which has improved small sample properties.
Keywords: Latent pervasive factors, Observable factors, Canonical correlations, Spanning, PCA
JEL Classification: C23, C38, C55, C12, E32
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