Interpreting the Latent Dynamic Factors by Threshold FAVAR Model

In this paper, we propose a latent threshold FAVAR model. The novelty is the interpretation of factors by observing how frequently factor loadings fall below estimated thresholds and become irrelevant. The results indicate that we are able to relate the factors to specific categories of the data without any prior specification on the data set. Furthermore, the interpretable factors, e.g., real activity factor, unemployment factor and such, are each given shocks along with policy shock to observe the responses of the other factors and individual series. The resulting impulse responses are of the expected sign and magnitude in general. Overall our results yield an intensive layout which factor is associated with different aspects of the economy and how the shocks affect the other factors and variables