Dynamic Factor Correlations

Bibliographic Data

ID21653568
AuthorsChen Tong (0000-0002-3065-5978, Department of Finance, School of Economics Xiamen University China), Peter Reinhard Hansen (0000-0001-9728-4860, Department of Economics University of North Carolina Chapel Hill North Carolina USA, corresponding author)
Year2026
Publication date2026-05-01
Open AccessYes
TypeARTICLE
VenueJournal of Applied Econometrics (JOURNAL)
Journal identifiersISSN: 1099-1255 • E-ISSN: 0883-7252
PublisherWiley (PUBLISHER • GB)
DOI10.1002/jae.70062
OpenAlexW7160035743
LanguageEN
References cited27

We introduce a dynamic factor correlation model whose core methodological innovation is a variation‐free parametrization of dynamic factor loadings, inspired by the generalized Fisher transformation. The model accommodates time‐varying correlations, heterogeneous heavy tails, and dependent idiosyncratic shocks. Applied to a Small Universe of 12 assets and a Large Universe of 323 stocks, the factor structure induces a sparse idiosyncratic correlation matrix with dependencies concentrated within subindustries, enabling scalability to high dimensions under a sparse block structure. Both factor loadings and correlations vary substantially. Allowing for heterogeneous heavy tails via convolution‐ distributions yields sizable improvements relative to Gaussian and multivariate‐ benchmarks

Correlation · Dynamic factor · Factor analysis · Gaussian · Parametrization (atmospheric modeling) · Scalability · Universe · Complex Systems and Time Series Analysis · Financial Markets and Investment Strategies · Financial Risk and Volatility Modeling

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