Does Principal Component Analysis Preserve the Sparsity in Sparse Weak Factor Models?

Author:

Jie Wei, Yonghui Zhang

Keyword:

Economics, Econometrics, Econometrics (econ.EM)

journal:

date:

2023-05-09 16:00:00

Abstract

This paper studies the principal component (PC) method-based estimation of weak factor models with sparse loadings. We uncover an intrinsic near-sparsity preservation property for the PC estimators of loadings, which comes from the approximately upper triangular (block) structure of the rotation matrix. It implies an asymmetric relationship among factors: the rotated loadings for a stronger factor can be contaminated by those from a weaker one, but the loadings for a weaker factor is almost free of the impact of those from a stronger one. More importantly, the finding implies that there is no need to use complicated penalties to sparsify the loading estimators. Instead, we adopt a simple screening method to recover the sparsity and construct estimators for various factor strengths. In addition, for sparse weak factor models, we provide a singular value thresholding-based approach to determine the number of factors and establish uniform convergence rates for PC estimators, which complement Bai and Ng (2023). The accuracy and efficiency of the proposed estimators are investigated via Monte Carlo simulations. The application to the FRED-QD dataset reveals the underlying factor strengths and loading sparsity as well as their dynamic features.

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