Econometrica: May, 2013, Volume 81, Issue 3

Eigenvalue Ratio Test for the Number of Factors

https://doi.org/10.3982/ECTA8968
p. 1203-1227

Seung C. Ahn, Alex R. Horenstein

This paper proposes two new estimators for determining the number of factors () in static approximate factor models. We exploit the well‐known fact that the largest eigenvalues of the variance matrix of response variables grow unboundedly as increases, while the other eigenvalues remain bounded. The new estimators are obtained simply by maximizing the ratio of two adjacent eigenvalues. Our simulation results provide promising evidence for the two estimators.

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