Abstract
This paper studies estimation and inference in diffusion indexes with structural instability. Factor model and factor augmented regression both experience a structural change with different unknown break dates. In the factor model, we estimate factors and loadings by principal components, and break fraction by concentrated least squares: convergence rates of the estimators are obtained, and model selection criteria robust to the unknown break date are introduced. We consider least squares estimation of the factor augmented regression and propose a break test. The empirical application uncovers potential instabilities in the linkages between bond risk premia and macroeconomic factors.
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