Factor Analysis of a Large DSGE Model

Abstract

We study the workings of the factor analysis of high-dimensional data using arti…cial series generated from a large, multi-sector dynamic stochastic general equilibrium (DSGE) model. The objective is to use the DSGE model as a laboratory that allow us to shed some light on the practical bene…ts and limitations of using factor analysis techniques on economic data. We explain in what sense the arti…cial data can be thought of having a factor structure, study the theoretical and fi…nite sample properties of the principal components estimates of the factor space, investigate the substantive reason(s) for the good performance of diffusion index forecasts, and assess the quality of the factor analysis of highly dissagregated data. In all our exercises, we explain the precise relationship between the factors and the basic macroeconomic shocks postulated by the model.Multisector economies, principal components, forecasting, pervasiveness, FAVAR