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Copula-based Stochastic Cost Frontier with Correlated Technical and Allocative Inefficiency

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  • Arabinda Das

    (Acharya Prafulla Chandra College)

Abstract

This paper considers the duality between stochastic frontier production and cost functions, under the assumption of cost minimization (technical and allocative inefficiency) and dependence structure for both measures of technical and allocative inefficiency as assumed by (Schmidt and Lovell, Journal of Econometrics 13:83–100, 1980). However, the assumed dependence structure comprise of positive dependence for higher technical inefficiency and higher (positive) allocative inefficiency; and negative dependence for higher technical inefficiency and higher (negative) allocative inefficiency through a mixture of copula model. The dependence structure is presented by a multivariate Farlie–Gumbel–Morgenstern (FGM) copula as there will be choice of probability distributions for both technical and allocative inefficiency. The proposed model is estimated using simulated maximum likelihood (SML) method. An application of the illustrated model to the US electricity utility data (Greene, Journal of Econometrics 46:141–164, 1990) shows a significant dependence between technical and allocative inefficiency.

Suggested Citation

  • Arabinda Das, 2021. "Copula-based Stochastic Cost Frontier with Correlated Technical and Allocative Inefficiency," Journal of Quantitative Economics, Springer;The Indian Econometric Society (TIES), vol. 19(2), pages 207-222, June.
    • Handle: RePEc:spr:jqecon:v:19:y:2021:i:2:d:10.1007_s40953-021-00230-6
    DOI: 10.1007/s40953-021-00230-6
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    References listed on IDEAS

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    1. Schmidt, Peter & Lovell, C. A. Knox, 1980. "Estimating stochastic production and cost frontiers when technical and allocative inefficiency are correlated," Journal of Econometrics, Elsevier, vol. 13(1), pages 83-100, May.
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    12. Jondrow, James & Knox Lovell, C. A. & Materov, Ivan S. & Schmidt, Peter, 1982. "On the estimation of technical inefficiency in the stochastic frontier production function model," Journal of Econometrics, Elsevier, vol. 19(2-3), pages 233-238, August.
    13. Schmidt, Peter & Knox Lovell, C. A., 1979. "Estimating technical and allocative inefficiency relative to stochastic production and cost frontiers," Journal of Econometrics, Elsevier, vol. 9(3), pages 343-366, February.
    14. Arabinda Das, 2015. "Copula-based Stochastic Frontier Model with Autocorrelated Inefficiency," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 7(2), pages 111-126, June.
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    1. Armando Sánchez-Vargas & José Manuel Márquez-Estrada & Eric Hernández-Ramírez, 2023. "Uncovering the Link Between the Theoretical and Probabilistic Models of the Global Production Function: A Copula Approach," Journal of Quantitative Economics, Springer;The Indian Econometric Society (TIES), vol. 21(2), pages 289-315, June.

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