Dynamic clustering of multivariate panel data

We propose a dynamic clustering model for studying time-varying group structures in multivariate panel data. The model is dynamic in three ways: First, the cluster means and covariance matrices are time-varying to track gradual changes in cluster characteristics over time. Second, the units of interest can transition between clusters over time based on a Hidden Markov model (HMM). Finally, the HMM’s transition matrix can depend on lagged cluster distances as well as economic covariates. Monte Carlo experiments suggest that the units can be classified reliably in a variety of settings. An empirical study of 299 European banks between 2008Q1 and 2018Q2 suggests that banks have become less diverse over time in key characteristics. On average, approximately 3% of banks transition each quarter. Transitions across clusters are related to cluster dissimilarity and differences in bank profitability.