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A SUGGESTION FOR A DYNAMIC MULTIFACTOR MODEL (DMFM)

Published online by Cambridge University Press:  11 January 2021

Heather D. Gibson ,
Stephen G. Hall  and
George S. Tavlas
Heather D. Gibson
Affiliation:
Bank of Greece
Stephen G. Hall
Affiliation:
University of Leicester, Bank of Greece and University of Pretoria
George S. Tavlas*
Affiliation:
Bank of Greece and Hoover Institution, Stanford University
*
Address correspondence to: George S. Tavlas, Bank of Greece, 21 E Venizelos Ave, Athens, 10250, Greece. e-mail: [email protected]. Phone: +30 210 320 2370; Fax: +30 210 320 2432.
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Abstract

We provide a new way of deriving a number of dynamic unobserved factors from a set of variables. We show how standard principal components may be expressed in state space form and estimated using the Kalman filter. To illustrate our procedure, we perform two exercises. First, we use it to estimate a measure of the current account imbalances among northern and southern euro area countries that developed during the period leading up to the outbreak of the euro area crisis, before looking at adjustment in the post-crisis period. Second, we show how these dynamic factors can improve forecasting of the euro exchange rate.

Keywords

Principal ComponentsFactor ModelsUnderlying ActivityForecasts
Type
Articles
Information
Macroeconomic Dynamics , Volume 26 , Issue 6 , September 2022 , pp. 1423 - 1443
Copyright
© Cambridge University Press 2021

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