Modelling Efficiency Effects in a True Fixed Effects Stochastic Frontier

Abstract

This paper proposes a stochastic frontier panel data model which includes time-invariant unobserved heterogeneity along with the efficiency effects. Following Paul and Shankar (2018), the efficiency effects are specified by a standard normal cumulative distribution function of exogenous variables which ensures the efficiency scores to lie in a unit interval. This specification eschews one-sided error term present in almost all the existing inefficiency effects models. The model parameters can be estimated by non-linear least squares after removing the individual effects by the usual within transformation or using non-linear least squares dummy variables (NLLSDV) estimator. The efficiency scores are directly calculated once the model is estimated. An empirical illustration based on widely used panel data on Indian farmers is presented.

Keywords: Fixed Effects; Stochastic Frontier; Technical Efficiency; Standard Normal Cumulative Distribution Function; Non-Linear Least Squares

JEL Classification: C51; D24; Q12