Permanent-Transitory decomposition of cointegrated time series via dynamic factor models, with an application to commodity prices

Author:

Casoli Chiara1,Lucchetti Riccardo (Jack)2

Affiliation:

1. Fondazione Eni Enrico Mattei, Corso Magenta 63, 20123, Milano, Italy

2. Università Politecnica delle Marche, Deparment of Economic and Social Sciences, Piazzale Martelli 8, 60121, Ancona, Italy

Abstract

Summary We propose a cointegration-based Permanent-Transitory decomposition for nonstationary dynamic factor models (DFMs). Our methodology exploits the cointegration relations among the observable variables and assumes they are driven by a common and an idiosyncratic component. The common component is further split into a long-term nonstationary and a short-term stationary part. A Monte Carlo experiment shows that incorporating the cointegration structure into the DFM leads to a better reconstruction of the space spanned by the factors, compared to the most standard technique of applying a factor model in differenced systems. We apply our procedure to a set of commodity prices to analyse the co-movement among different markets and find that commodity prices move together mostly due to long-term common forces; while the trend for the prices of most primary goods is declining, metals and energy exhibit an upward or at least stable pattern since the 2000s.

Publisher

Oxford University Press (OUP)

Subject

Economics and Econometrics

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