DP10417 A spectral EM algorithm for dynamic factor models

Author(s): Gabriele Fiorentini, Alessandro Galesi, Enrique Sentana
Publication Date: February 2015
Keyword(s): Indirect inference, Kalman filter, Sectoral employment, Spectral maximum likelihood, Wiener-Kolmogorov filter
JEL(s): C32, C38, C51
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10417

We introduce a frequency domain version of the EM algorithm for general dynamic factor models. We consider both AR and ARMA processes, for which we develop iterative indirect inference procedures analogous to the algorithms in Hannan (1969). Although our proposed procedure allows researchers to estimate such models by maximum likelihood with many series even without good initial values, we recommend switching to a gradient method that uses the EM principle to swiftly compute frequency domain analytical scores near the optimum. We successfully employ our algorithm to construct an index that captures the common movements of US sectoral employment growth rates.