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Canonical Correlation-based Model Selection for the Multilevel Factors

Author

Listed:
  • In Choi

    (Department of Economics, Sogang University, Seoul)

  • Rui Lin

    (Department of Economics, University of York.)

  • Yongcheol Shin

    (Department of Economics, University of York.)

Abstract
A great deal of research e ort has been devoted to the analysis of the multilevel factor model. To date, however, limited progress has been made on the development of coherent inference for identifying the number of the global factors. We propose a novel approach based on the canonical correlation analysis to identify the number of the global factors. We develop the canonical correlations di erence (CCD), which is constructed by the di erence between the cross group-averages of the adjacent canonical correlations between factors. We prove that CCD is a consistent selection criterion. Via Monte Carlo simulations, we show that CCD always selects the number of global factors correctly even in small samples. Further, CCD outperforms the existing approaches in the presence of serially correlated and weakly cross-sectionally correlated idiosyncratic errors as well as the correlated local factors. Finally, we demonstrate the utility of our framework with an application to the multilevel asset pricing model for the stock return data of 12 industries in the U.S.

Suggested Citation

  • In Choi & Rui Lin & Yongcheol Shin, 2020. "Canonical Correlation-based Model Selection for the Multilevel Factors," Working Papers 2008, Nam Duck-Woo Economic Research Institute, Sogang University (Former Research Institute for Market Economy).
    • Handle: RePEc:sgo:wpaper:2008
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    References listed on IDEAS

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    Cited by:

    1. Jie Wei & Yonghui Zhang, 2023. "Does Principal Component Analysis Preserve the Sparsity in Sparse Weak Factor Models?," Papers 2305.05934, arXiv.org, revised Nov 2024.

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    More about this item

    Keywords

    Multilevel Factor Models; Principal Components; Canonical Correlation Difference; Multilevel Asset Pricing Models;
    All these keywords.

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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