Estimation of Banking Technology Under Credit Uncertainty

Documentos de trabajo Economía y Finanzas No 13-19

Empirical Economics, Forthcoming

32 Pages Posted: 10 Feb 2014 Last revised: 12 Mar 2015

See all articles by Emir Malikov

Emir Malikov

University of Nevada, Las Vegas

Diego A. Restrepo-Tobon

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF); State University of New York (SUNY) at Binghamton - Department of Economics; EAFIT University

Subal C. Kumbhakar

State University of New York (SUNY) at Binghamton - Department of Economics

Date Written: August 30, 2013

Abstract

Credit risk is crucial to understanding banks’ production technology and should be explicitly accounted for when modeling the latter. The banking literature has largely accounted for risk by using ex-post realizations of banks’ uncertain outputs and the variables intended to capture risk. This is equivalent to estimating an ex-post realization of bank’s production technology which, however, may not reflect optimality conditions that banks seek to satisfy under uncertainty. The ex-post estimates of technology are likely to be biased and inconsistent, and one thus may call into question the reliability of the results regarding banks’ technological characteristics broadly reported in the literature. However, the extent to which these concerns are relevant for policy analysis is an empirical question. In this paper, we offer an alternative methodology to estimate banks’ production technology based on the ex-ante cost function. We model credit uncertainty explicitly by recognizing that bank managers minimize costs subject to given expected outputs and credit risk. We estimate unobservable expected outputs and associated credit risk levels from banks’ supply functions via nonparametric kernel methods. We apply this framework to estimate production technology of U.S. commercial banks during the period from 2001 to 2010 and contrast the new estimates with those based on the ex-post models widely employed in the literature.

Keywords: Ex-Ante Cost Function, Production Uncertainty, Productivity, Returns to Scale, Risk

JEL Classification: C10, D81, G21

Suggested Citation

Malikov, Emir and Restrepo-Tobon, Diego A. and Kumbhakar, Subal C., Estimation of Banking Technology Under Credit Uncertainty (August 30, 2013). Documentos de trabajo Economía y Finanzas No 13-19, Empirical Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2393181 or http://dx.doi.org/10.2139/ssrn.2393181

Emir Malikov

University of Nevada, Las Vegas ( email )

4505 S. Maryland Parkway
Las Vegas, NV 89154
United States

Diego A. Restrepo-Tobon (Contact Author)

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF) ( email )

Carrera 49 No. 7 South - 50
Medellin
Colombia

State University of New York (SUNY) at Binghamton - Department of Economics ( email )

Binghamton, NY 13902-6000
United States

EAFIT University ( email )

Carrera 49 N° 7 sur – 50
Medellin, Antioquia 00000
Colombia

Subal C. Kumbhakar

State University of New York (SUNY) at Binghamton - Department of Economics ( email )

Binghamton, NY 13902-6000
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
20
Abstract Views
350
PlumX Metrics