Introduction to Convergence Analysis with convergenceDFM

Introduction

convergenceDFM analyzes economic convergence between two panels of series (for example, labour-value price indices X and market price indices Y) combining Dynamic Factor Models (DFM) with discrete-time, mean-reverting Ornstein-Uhlenbeck / AR(1) factor processes, plus formal convergence and coupling tests.

Basic usage

The end-to-end entry point is run_complete_factor_analysis_robust(). The example below uses simulated data and skips the Bayesian OU step (which needs a Stan backend); set skip_ou = FALSE to run it.

set.seed(123)
X <- matrix(rnorm(120 * 8), 120, 8)               # labour-value price indices
Y <- X + matrix(rnorm(120 * 8, 0, 0.5), 120, 8)   # market price indices

res <- run_complete_factor_analysis_robust(
  X_matrix = X, Y_matrix = Y,
  max_comp = 3, dfm_lags = 1,
  skip_ou  = TRUE,
  make_plots = FALSE,
  verbose  = FALSE
)

res$dfm$r2_global        # in-sample fit of the factor VAR
res$dfm$half_life_dominant

Coupling significance (corrected null)

To assess whether the X factors lead the Y factors beyond chance, use the time-shift null. Do not rely on a rotation null: the coupling statistics are invariant to orthogonal rotation, so a rotation null cannot reject (see the methodological notes).

null <- run_rotation_null_on_results(res, B = 500, seed = 1,
                                     null_method = "circular_shift")
null$p_values        # Monte Carlo one-sided p-values
null$p_values_fdr    # Benjamini-Hochberg adjusted

The out-of-sample channel (does lagged X improve the forecast of Y?) is tested with a Clark-West statistic:

dr <- deltaR2_ou(res, lag = 1, oos = TRUE, seed = 1, verbose = FALSE)
dr$OOS$delta_r2_oos
dr$OOS$cw_p          # Clark-West p-value

Convergence test

With a Stan backend, estimate_factor_OU() returns MCMC diagnostics and a genuine mean-reversion test: a factor is convergent only if the entire credible interval of its persistence phi lies inside (-1, 1). Because phi is not constrained to (0, 1), the test can fail to find convergence – it is not true by construction.

Methodological notes and design decisions

This section documents choices that are easy to misread.

1. The OU model is discrete-time AR(1). The estimated object is a first-order vector autoregression with cross-equation coupling, the discrete-time analogue of a coupled Ornstein-Uhlenbeck system. For a series sampled at interval , persistence maps to the continuous mean-reversion speed by , i.e. , and the half-life is periods. phi is given a generous support (-1.5, 1.5) and a weakly-informative, convergence-neutral prior normal(0.5, 0.5) so the posterior can place mass on unit-root or explosive dynamics; convergence is then a testable conclusion.

2. Factors are PLS scores, not principal components. Factor extraction is supervised (Partial Least Squares uses Y), which makes the in-sample fit of “Y from X factors” optimistic. Always read the out-of-sample diagnostics (r2_oos_*, the Clark-West test) rather than the in-sample R^2. This differs from the principal-component DFM of Stock-Watson; the references describe the spirit of the approach, not an identical estimator.

3. The coupling null breaks time, not basis. Procrustes, canonical correlations, principal angles and the dynamic-beta norm are invariant to orthogonal rotation of either factor space. A rotation-based null is therefore degenerate. The valid null circularly shifts Y in time (or block-bootstraps it), preserving each series’ own autocorrelation while destroying the cross-series alignment.

4. Residual unit-root tests use generated regressors. The equilibrium errors fed to ADF/PP are built from estimated OU parameters. Standard Dickey-Fuller critical values over-reject on such residuals; corroborate any rejection with test_cointegration_control() (Johansen). The package flags this with a warning and a caveat field.

5. The CPI “disaggregation” is a convex weight blend. It mixes a base weight matrix with a time-distributed, SVD-derived data weight via . There is no likelihood and no Bayes’ rule; the historical “Bayesian”/“posterior” naming is kept only for backward compatibility.

6. The global index is a heuristic summary. The 0-1 convergence/robustness indices aggregate transformed sub-scores with fixed thresholds. Treat the verdict as a summary, not a calibrated probability; base inference on the individual tests and their FDR-adjusted p-values.

Reproducibility

Every stochastic routine accepts and honours a seed. The pipeline takes a single master seed and threads it through data jitter, component selection, OU sampling and the robustness tests.