Dynamic factor

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In econometrics a dynamic factor (also known as a diffusion index) is a series which measures the co-movement of many time series. It is used in macroeconomic models.

Formally

X t = Λ t F t + e t,

where $F_{t}=(f^{\top}_{t},\dots,f^{\top}_{t-q})$ is the vector of lagged factors of the variables in the $T \times N$ matrix $X t$ (T is the number of observations and N is the number of variables), $Λ t$ are the factor loadings, and $e t$ is the factor error.

[edit] Literature

Forni, Mario & Lippi, Marco, 2001. The Generalized Dynamic Factor Model: Representation Theory, Econometric Theory, vol. 17(6), pages 1113-41.
Stock, James H & Watson, Mark W, 2002. Macroeconomic Forecasting Using Diffusion Indexes, Journal of Business & Economic Statistics, vol. 20(2), pages 147-62.