WHY DO WE USE FACTOR ANALYSIS……..?

This blog will outline factor analysis applications relevant to various scientific and policy concerns:

Interdependency and pattern delineation. If a scientist has a table of data--say, UN votes, personality characteristics, or answers to a questionnaire--and if he suspects that these data are interrelated in a complex fashion, then, factor analysis may be used to untangle the linear relationships into their separate patterns. Each pattern will appear as a factor delineating a distinct cluster of interrelated data.

Parsimony or data reduction. Factor analysis can be useful for reducing a mass of information to an economical description. For example, data on fifty characteristics for 300 nations are unwieldy to handle, descriptively or analytically. The management, analysis, and understanding of such data are facilitated by reducing them to their common factor patterns. These factors concentrate and index the dispersed information in the original data and can therefore replace the fifty characteristics without much loss of information. Nations can be more easily discussed and compared on economic development, size, and politics dimensions, for example, than on the hundreds of characteristics each dimension involves.

Structure. Factor analysis may be employed to discover the basic structure of a domain. As a case in point, a scientist may want to uncover the primary independent lines or dimensions--such as size, leadership, and age--of variation in group characteristics and behavior. Data collected on a large sample of groups and factor analyzed can help disclose this structure.

Classification or description. Factor analysis is a tool for developing an empirical typology. It can be used to group interdependent variables into descriptive categories, such as ideology, revolution, liberal voting, and authoritarianism. It can be used to classify nation profiles into types with similar characteristics or behavior. Or it can be used on data matrices of a transaction type or a social-choice type to show how individuals, social groups, or nations cluster on their transactions with or choices of each other.

Scaling. A scientist often wishes to develop a scale on which individuals, groups, or nations can be rated and compared. The scale may refer to such phenomena as political participation, voting behavior, or conflict. A problem in developing a scale is to weight the characteristics being combined. Factor analysis offers a solution by dividing the characteristics into independent sources of variation (factors). Each factor then represents a scale based on the empirical relationships among the characteristics. As additional findings, the factor analysis will give the weights to employ for each characteristic when combining them into the scales.

Hypothesis testing. Hypotheses abound regarding dimensions of attitude, personality, group, social behavior, voting, and conflict. Since the meaning usually associated with "dimension" is that of a cluster or group of highly inter-correlated characteristics or behavior, factor analysis may be used to test for their empirical existence. Which characteristics or behavior should, by theory, be related to which dimensions can be postulated in advance and statistical tests of significance can be applied to the factor analysis results.

Besides those relating to dimensions, there are other kinds of hypotheses that may be tested. To illustrate: if the concern is with a relationship between economic development and instability, holding other things constant, a factor analysis can be done of economic and instability variables along with other variables that may affect (hide, mediate, depress) their relationship. The resulting factors can be so defined (rotated) that the first several factors involve the mediating measures (to the maximum allowed by the empirical relationships). A remaining independent factor can be calculated to best define the postulated relationships between the economic and instability measures. The magnitude of involvement of both variables in this pattern enables the scientist to see whether an economic development-instability pattern actually exists when other things are held constant.

Author- Sahil Singhal

Finance Group 3