This article proposes a solution to one of the issues in the rapidly growing literature on dynamic factor models, i.e., how to determine the optimal number of factors. Our formal test, based upon the canonical correlation procedure related to concepts from information theory, produces estimates...

The paper proposes a data driven adaptive model selection strategy. The selection crite- rion measures economic ex–ante forecasting content by means of trading implied cash flows. Empirical evidence suggests that the proposed strategy is neither exposed to selection bias nor to the risk of...

In the application of the popular maximum likelihood method to factor analysis, the number of factors is commonly determined through a two-stage procedure, in which stage 1 performs parameter estimation for a set of candidate models and then stage 2 chooses the best according to certain model...

In this paper we develop some econometric theory for factor models of large dimensions. The focus is the determination of the number of factors, which is an unresolved issue in the rapidly growing literature on multifactor models. We propose some panel C(p) criteria and show that the number of...