Dynamic factor models: A review of the literature

Abstract

In the last few years, the growth in the amount of economic and financial data available has prompted econometricians to develop or adapt new methods enabling them to summarise efficiently the information contained in large databases. Of these methods, dynamic factor models have seen rapid growth and become very popular among macroeconomists. In this paper, we carry out a survey of recent literature on dynamic factor models. We start by presenting the models used before looking at parameter estimation methods and statistical tests available for choosing the number of factors. We then focus on recent empirical applications dealing with the construction of economic outlook indicators, macroeconomic forecasts, and both macroeconomic and monetary policy analyses.