Adaptive factor modeling

We consider the classical factor model of Jöreskog (1969) within a change point detection framework with the aim of discovering intervals of local homogeneity of the model. Our tests for structural breaks in the variance (homogeneity in variance) as well as both in the mean and the variance (complete homogeneity) are based on a maximum statistic of sequential generalized likelihood ratios. We approximate the small-sample distribution by means of a multiplier bootstrap. To handle the high-dimensional parameter problem, we suggest a novel bias correction for the multiplier bootstrap. Simulations show that the tests perform very well in terms of size and power. In our empirical application, we study structural breaks for moderately sized equity portfolios.