Permanent-Transitory decomposition of cointegrated time series via dynamic factor models, with an application to commodity prices
Chiara Casoli (Fondazione Eni Enrico Mattei); Riccardo Lucchetti (Deparment of Economic and Social Sciences, Università Politecnica delle Marche)
C32, C38, Q02
Cointegration, Dynamic Factor Models, P-T decomposition, Commodity prices co-movement
The Econometrics Journal, Vol. 25, N. 2 (May 2022)
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.