Analysis on the individual efficiency prediction in the composed error frontier model: a Monte Carlo study

Abstract

This study seeks to analyse some important questions related to the Stochastic Frontier Model, such as the method proposed by Jondrow et al (1982) to separate the error term into its two components, and the measure of efficiency given by Timmer (1971). To this purpose, a Monte Carlo experiment has been carried out using the Half-Normal and Normal- Exponential specifications throughout the rank of the γ parameter. The estimation errors have been eliminated, so that the intrinsic variability of the conditional of u given ε can be evaluated. In addition, the behaviour of the mean and mode as point estimators of u is investigated. The results have yielded some interesting findings. We have observed that both the point estimates and the mean efficiency are more precise in cases of lower efficiency. This occurs when the variable that generates the inefficiency outweighs the one that picks up the errors out of the control. The change in order found between the estimated efficiency and its true value is misleadingly high especially for low γ, which underlines the risk of estimating at these values