Common Factors
Heather M. Anderson · The New Palgrave Dictionary of Economics · 2008
Economic analysis frequently involves the study of variables that exhibit similar behaviour, and it is often of interest to model this comovement. Well-known examples of comovement in multivariate data sets include business cycles in macroeconomic indicators and shifts in the entire term structure of interest rates, and researchers sometimes attribute this comovement to a small set of underlying forces or latent ‘factors’ that influence each variable in the system. It is then convenient to think of the variation in each variable in the system as the sum of two types of (unobserved) components, one of which captures variation that is due to ‘common factors’, while the other captures all other variation. Models that attribute comovement to common factors are called common factor models, and common factor analysis involves the identification and study of the common factors.