Opening the Black Box: Structural Factor Models with Large Cross-Sections

41 Pages Posted: 19 Jan 2007

See all articles by Mario Forni

Mario Forni

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics; Centre for Economic Policy Research (CEPR)

Domenico Giannone

Federal Reserve Banks - Federal Reserve Bank of New York; Centre for Economic Policy Research (CEPR)

Marco Lippi

Dipartimento di Scienze Economiche (DiSSE); Einaudi Institute for Economics and Finance (EIEF)

Lucrezia Reichlin

London Business School; Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES); Centre for Economic Policy Research (CEPR); European Central Bank (ECB)

Date Written: January 2007

Abstract

This paper shows how large-dimensional dynamic factor models are suitable for structural analysis. We establish sufficient conditions for identification of the structural shocks and the associated impulse-response functions. In particular, we argue that, if the data follow an approximate factor structure, the "problem of fundamentalness," which is intractable in structural VARs, can be solved provided that the impulse responses are sufficiently heterogeneous. Finally, we propose a consistent method (and n, T rates of convergence) to estimate the impulse-response functions, as well as a bootstrapping procedure for statistical inference.

Keywords: Dynamic factor models, structural VARs, identification, fundamentalness

JEL Classification: E0, C1

Suggested Citation

Forni, Mario and Giannone, Domenico and Lippi, Marco and Reichlin, Lucrezia, Opening the Black Box: Structural Factor Models with Large Cross-Sections (January 2007). ECB Working Paper No. 712. Available at SSRN: https://ssrn.com/abstract=954706

Mario Forni (Contact Author)

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics ( email )

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Domenico Giannone

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

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Centre for Economic Policy Research (CEPR)

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Marco Lippi

Dipartimento di Scienze Economiche (DiSSE) ( email )

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Einaudi Institute for Economics and Finance (EIEF) ( email )

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Lucrezia Reichlin

London Business School ( email )

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Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES) ( email )

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Centre for Economic Policy Research (CEPR)

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European Central Bank (ECB) ( email )

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