Correct specification the number of factors is a fundamental issue for the application of factor models. In this paper we develop an econometric method to estimate the number of factors for factor models of large dimensions where the number of factors is allowed to increase as the two dimensions, cross-sections (N) and time dimensions (T) increase. Using information criterion similar to those proposed by Bai and Ng (2002, Econometrica), we establish our estimation procedure and show that the number of factors can be consistently estimated using the criteria. Also, we conduct Monte-Carlo simulation to investigate the finite sample properties of the proposed approach.

Joint work with Hongjun Li, and Yutang Shi.