Implications of Dynamic Factor Models for VAR Analysis

67 Pages Posted: 8 Aug 2005  

James H. Stock

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Mark W. Watson

Princeton University - Woodrow Wilson School of Public and International Affairs; National Bureau of Economic Research (NBER)

Date Written: July 2005

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

Stock, James H. and Watson, Mark W., Implications of Dynamic Factor Models for VAR Analysis (July 2005). NBER Working Paper No. w11467. Available at SSRN: https://ssrn.com/abstract=755703

James H. Stock (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
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National Bureau of Economic Research (NBER)

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Harvard University - Harvard Kennedy School (HKS) ( email )

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Mark W. Watson

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Princeton University - Woodrow Wilson School of Public and International Affairs ( email )

Princeton University
Princeton, NJ 08544-1021
United States

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