In an influential paper, Pesaran [Pesaran, M.H. (2006). Estimation and inference in large heterogeneous panels with a multifactor error structure. Econometrica 74, 967-1012] proposes a very simple estimator of factor-augmented regressions that has since then become very popular. In this note we demonstrate how the presence of correlated factor loadings can render this estimator inconsistent. (C) 2013 Elsevier B.V. All rights reserved.
- Factor-augmented panel regressions
- Common factor models
- Cross-sectional averages
- Cross-sectional dependence
Westerlund, J., & Urbain, J. R. Y. J. (2013). On the estimation and inference in factor-augmented panel regressions with correlated loadings. Economics Letters, 119(3), 247-250. https://doi.org/10.1016/j.econlet.2013.03.022