SMOOTH DYNAMIC FACTOR ANALYSIS WITH APPLICATION TO THE US TERM STRUCTURE OF INTEREST RATES |
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| Authors: | Borus Jungbacker Siem Jan Koopman Michel van der Wel |
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| Institution: | 1. Department of Econometrics, VU University Amsterdam, Netherlands;2. Tinbergen Institute, Netherlands;3. Erasmus School of Economics, ERIM Rotterdam and CREATES, Aarhus, Denmark |
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| Abstract: | We consider the dynamic factor model and show how smoothness restrictions can be imposed on factor loadings by using cubic spline functions. We develop statistical procedures based on Wald, Lagrange multiplier and likelihood ratio tests for this purpose. The methodology is illustrated by analyzing a newly updated monthly time series panel of US term structure of interest rates. Dynamic factor models with and without smooth loadings are compared with dynamic models based on Nelson–Siegel and cubic spline yield curves. We conclude that smoothness restrictions on factor loadings are supported by the interest rate data and can lead to more accurate forecasts. Copyright © 2013 John Wiley & Sons, Ltd. |
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