Observed and Unobserved Heterogeneity in Stochastic Frontier Models: An Application to the Electricity Distribution Industry
22 Pages Posted: 11 Nov 2009
Date Written: September 30, 2009
Abstract
In this study we combine different possibilities to model firm level heterogeneity in Stochastic Frontier Analysis. We show that both observed and unobserved heterogeneity cause serious biases in inefficiency results if left unmodelled. Modelling observed and unobserved heterogeneity treats individual firms in different ways and even though the mean inefficiency scores in both cases diminish the firm level efficiency rank orders turn out to be very different. The best fit with the data is obtained by modelling unobserved heterogeneity through randomising frontier parameters and at the same time explicitly modelling the observed heterogeneity into the inefficiency distribution. These results are obtained by using data of Finnish electricity distribution utilities and the results are relevant in relation to electricity distribution pricing and regulation.
Keywords: cost efficiency, heterogeneity, electricity distribution, benchmarking, random parameter
JEL Classification: C13, C23, D24, L51, L94
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
The Behavior of the Fixed Effects Estimator in Nonlinear Models,
-
The Revenues-Expenditures Nexus: Evidence from Local Government Data
By Douglas Holtz-eakin, Whitney K. Newey, ...
-
A Two-Stage Estimator for Probit Models with Structural Group Effects
-
Convenient Estimators for the Panel Probit Model: Further Results
-
Simulated Likelihood Estimation of the Normal-Gamma Stochastic Frontier Function