Working Paper

Quasi Maximum Likelihood Estimation and Inference of Large Approximate Dynamic Factor Models via the EM algorithm

Abstract: We study estimation of large Dynamic Factor models implemented through the Expectation Maximization (EM) algorithm, jointly with the Kalman smoother. We prove that as both n and T diverge to infinity: (i) the estimated loadings are \\sqrt{T}-consistent and asymptotically normal and equivalent to their Quasi Maximum Likelihood estimates; (ii) the estimated factors are \\sqrt{n}-consistent and asymptotically normal and equivalent to their Weighted Least Squares estimates. Moreover, the estimated loadings are asymptotically as efficient as those obtained by Principal Components analysis, while the estimated factors are more efficient if the idiosyncratic covariance is sparse enough.

Keywords: Approximate Dynamic Factor Model; Expectation Maximization Algorithm; Kalman Smoother; Quasi Maximum Likelihood;

JEL Classification: C58; C32; C55;

https://doi.org/10.17016/FEDS.2024.086

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2024-10-24

Number: 2024-086