An overview of the factor-augmented error-correction model

Abstract

The Factor-augmented Error Correction Model (FECM) generalizes the factoraugmented VAR (FAVAR) and the Error Correction Model (ECM), combining errorcorrection, cointegration and dynamic factor models. It uses a larger set of variables compared to the ECM and incorporates the long-run information lacking from the FAVAR because of the latter’s specification in differences. In this paper we review the specification and estimation of the FECM, and illustrate its use for forecasting and structural analysis by means of empirical applications based on Euro Area and US data.