Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2014:8: Estimation of Factor-Augmented Panel Regressions with Weakly Influential Factors

Joakim Westerlund () and Simon Reese ()
Additional contact information
Joakim Westerlund: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden
Simon Reese: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: The use of factor-augmented panel regressions has become very popular in recent years. Existing methods for such regressions require that the common factors are strong, such that their cumulative loadings rise proportionally to the number of cross-sectional units, which of course need not be the case in practice. Motivated by this, the current paper offers an indepth analysis of the effect of non-strong factors on two of the most popular estimators for factor-augmented regressions, namely, principal components (PC) and common correlated effects (CCE).

Keywords: Non-strong common factors; factor-augmented panel regressions; common factor models

JEL-codes: C12; C13; C33

86 pages, First version: February 13, 2014. Revised: January 27, 2014.

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