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Abstract: A latent Markov model admitting variation in the number of latent states at each time period is introduced. The model facilitates subjects switching latent states at each time period according to an inhomogeneous first-order Markov process, wherein transition matrices are generally rectangular. As a consequence, latent groups can merge, split, or be re-arranged. An application analyzing the progress of well-being of nations, as measured by the three dimensions of the Human Development Index over the last 25 years illustrates the approach.
Keywords: group merging, group splitting, Human Development Index, latent transitions.
JEL Classification: C1, I3