Discrete Time, Discrete State Latent Markov Modelling for Assessing and Predicting Household Acquisitions of Financial Products

Abstract

Summary The paper demonstrates application of the latent Markov model for assessing developments by individuals through stages of a process. This approach is applied by using a database on ownership of 12 financial products and various demographic variables. The latent Markov model derives latent classes, representing household product portfolios, and shows the relationship between class membership and household demographics. The analysis provides insight into switching between the latent classes, reflecting developments of individual household product portfolios, and the effects of demographics on such switches. Based on this, we formulate equations to predict future acquisitions of financial products. The model accurately predicts which product a specific household unit acquires next, for most of the products.