Abstract
Practitioners often standardize panel data before estimating a factor model. In this paper we show an example that the standardization leads to inconsistent estimation of the factor number. When the common component exhibits strong heteroskedasticity, the conventional eigenvalue-based decompositions are consistent but standardization does not necessarily result in consistent estimation. To overcome this issue, we recommend using a "minimum-rule" whereby the minimum factor-number estimated from both the conventional and standardized panel is used. Monte Carlo studies and an empirical application are provided.
Original language | English |
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Pages (from-to) | 79-88 |
Number of pages | 10 |
Journal | Journal of Economic Theory and Econometrics |
Volume | 23 |
Issue number | 2 |
Publication status | Published - 2012 Jun |
Keywords
- Bai-Ng criteria
- Factor model
- Panel data
- Principal components estimator
- Selection criteria
- Standarization
ASJC Scopus subject areas
- Economics and Econometrics