Journal of Economic Theory and Econometrics: Journal of the Korean Econometric Society
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Journal of Economic Theory and Econometrics
Journal of the Korean Econometric Society

• #### Donggyu Sul   (University of Texas at Dallas)

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.

Keywords
Factor Model, Selection Criteria, Principal Components Estimator, Bai-Ng Criteria, Standarization, Panel Data

JEL classification codes
C33