University of Oulu

Observed and unobserved heterogeneity in stochastic frontier models

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Author: Kopsakangas-Savolainen, Maria1; Svento, Rauli1
Organizations: 1University of Oulu, Faculty of Economics, Department of Economics
Format: ebook
Version: published version
Access: open
Online Access: PDF Full Text (PDF, 1 MB)
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Language: English
Published: 2008
Publish Date: 2008-08-28


Stochastic frontier modeling has proceeded rapidly recently. Heterogeneity modeling internalized into frontier estimation has opened up new promising possibilities. In this paper we study different ways of considering heterogeneity in stochastic frontier models. It is possible to take heterogeneity into account by including those effects in the mean and/or variance of the distribution of inefficiency (observed heterogeneity) or by randomizing some parameters of the stochastic frontier model (unobserved heterogeneity). We compare the advantages of heterogeneity including models over the conventional random effects models for measuring the cost efficiency of electricity distribution utilities. Our results indicate that in all heterogeneity accounting models mean inefficiency decreases significantly compared to the basic random effects model. According to our results randomizing some of the parameters seems to help to capture the unobserved heterogeneity and hence this kind of firm specific heterogeneity does not appear as inefficiency in our estimation results. Notable is that the model which accounts observed heterogeneity and the models which account unobserved heterogeneity produce clearly different rank orders.

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Series: University of Oulu, Department of Economics, Working papers
Issue: 805
Copyright information: © University of Oulu, 2008. This publication is copyrighted. You may download, display and print it for your own personal use. Commercial use is prohibited.