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Onatski, A. and Wang, C.

Spurious Factor Analysis

WP Number: 2001

Abstract: This paper draws parallels between the Principal Components Analysis of factorless high-dimensional nonstationary data and the classical spurious regression. We show that a few of the principal components of such data absorb nearly all the data variation. The corresponding scree plot suggests that the data contain a few factors, which is collaborated by the standard panel information criteria. Furthermore, the Dickey-Fuller tests of the unit root hypothesis applied to the estimated “idiosyncratic terms” often reject, creating an impression that a few factors are responsible for most of the non-stationarity in the data. We warn empirical researchers of these peculiar effects and suggest to always compare the analysis in levels with that in differences.

Keywords: Spurious regression, principal components, factor models, Karhunen-Loève expansion.

Author links: Alexey Onatskiy  

PDF: wp2001.pdf

Open Access Link: 10.17863/CAM.52423

Keynes Fund Project(s):
High-dimensional Cointegration Analysis (JHOY)  

Theme: empirical

Published Version of Paper: Spurious Factor Analysis, Onatski, A. and Wang, C., Econometrica (2021)