Testing for Common Trends in Nonstationary Large Datasets. Issue 3 (16th June 2022)

• Record Type: Journal Article
• Authors: Barigozzi, Matteo; Trapani, Lorenzo
• Is Part Of: Journal of business & economic statistics. Volume 40:Issue 3(2022)
• Page Start: 1107
• Page End: 1122
• Publication Date: 2022-06-16
• Subjects: Common trends -- Nonstationary large panels -- Randomized tests; Economics -- Statistical methods -- Periodicals; Commercial statistics -- Periodicals; Économie politique -- Méthodes statistiques -- Périodiques; Statistique commerciale -- Périodiques; 330.015195
• DOI: 10.1080/07350015.2021.1901719
• Languages: English
• ISSNs: 0735-0015

Abstract

Abstract: We propose a testing-based procedure to determine the number of common trends in a large nonstationary dataset. Our procedure is based on a factor representation, where we determine whether there are (and how many) common factors (i) with linear trends, and (ii) with stochastic trends. Cointegration among the factors is also permitted. Our analysis is based on the fact that those largest eigenvalues of a suitably scaled covariance matrix of the data corresponding to the common factor part diverge, as the dimension N of the dataset diverges, whilst the others stay bounded. Therefore, we propose a class of randomized test statistics for the null that the p th largest eigenvalue diverges, based directly on the estimated eigenvalue. The tests only requires minimal assumptions on the data-generating process. Monte Carlo evidence shows that our procedure has very good finite sample properties, clearly dominating competing approaches when no common trends are present. We illustrate our methodology through an application to the U.S. bond yields with different maturities observed over the last 30 years.