Rational Factor Analysis

36 Pages Posted: 5 Sep 2006

See all articles by Semyon Malamud

Semyon Malamud

Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Eugene Trubowitz

Swiss Federal Institute of Technology Zurich

Date Written: July 14, 2006

Abstract

In econometrics, phenomenologically modelling asset returns by an ad hoc low order polynomial in macroeconomic quantities is referred to as factor analysis. Here, we present a rational factor analysis for a weakly heterogeneous Lucas tree economy. The method is generally applicable.

We show that the equilibrium state price density process for a weakly heterogeneous economy is a 'globally' unique and smooth function of all relevant parameters. We explicitly compute the second order Taylor approximation and write it as a polynomial in macroeconomic quantities; e.g., aggregate consumption, cross-sectional variance of wealth, risk aversion and patience. The second order Taylor polynomial is an intrinsic and rigorous factor analysis of the economy.

The moral is: perturbation theory reveals the form of factor analysis one should look for in an econometric analysis.

Keywords: factor analysis, heterogeneity, perturbation theory, general equilibrium, existence, uniqueness

JEL Classification: C62, D58, G12, C78

Suggested Citation

Malamud, Semyon and Trubowitz, Eugene, Rational Factor Analysis (July 14, 2006). Available at SSRN: https://ssrn.com/abstract=928132 or http://dx.doi.org/10.2139/ssrn.928132

Semyon Malamud (Contact Author)

Ecole Polytechnique Federale de Lausanne ( email )

Lausanne, 1015
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Eugene Trubowitz

Swiss Federal Institute of Technology Zurich ( email )

Lausanne CH-1001
Switzerland

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