Heterogeneous Grouping Structures in Panel Data

Abstract

In this paper we examine the existence of heterogeneity within a group, in panels with latent grouping structure. The assumption of within group homogeneity is prevalent in this literature, implying that the formation of groups alleviates cross-sectional heterogeneity, regardless of the prior knowledge of groups. While the latter hypothesis makes inference powerful, it can be often restrictive. We allow for models with richer heterogeneity that can be found both in the cross-section and within a group, without imposing the simple assumption that all groups must be heterogeneous. We further contribute to the method proposed by \cite{su2016identifying}, by showing that the model parameters can be consistently estimated and the groups, while unknown, can be identifiable in the presence of different types of heterogeneity. Within the same framework we consider the validity of assuming both cross-sectional and within group homogeneity, using testing procedures. Simulations demonstrate good finite-sample performance of the approach in both classification and estimation, while empirical applications across several datasets provide evidence of multiple clusters, as well as reject the hypothesis of within group homogeneity.