Combining Uncertainty with Uncertainty to Get Certainty? Efficiency Analysis for Regulation Purposes

93 Pages Posted: 16 Oct 2018

See all articles by Mark Andor

Mark Andor

RWI – Leibniz Institute for Economic Research

Stephan Sommer

RWI - Leibniz-Institute for Economic Research

Christopher Parmeter

University of Miami

Date Written: October 9, 2018

Abstract

Data envelopment analysis (DEA) and stochastic frontier analysis (SFA), as well as combinations thereof, are widely applied in incentive regulation practice, where the assessment of efficiency plays a major role in regulation design and benchmarking. Using a Monte Carlo simulation experiment, this paper compares the performance of six alternative methods commonly applied by regulators. Our results demonstrate that combination approaches, such as taking the maximum or the mean over DEA and SFA efficiency scores, have certain practical merits and might offer an useful alternative to strict reliance on a singular method. In particular, the results highlight that taking the maximum not only minimizes the risk of underestimation, but can also improve the precision of efficiency estimation. Based on our results, we give recommendations for the estimation of individual efficiencies for regulation purposes and beyond.

Keywords: Data Envelopment Analysis; Stochastic Frontier Analysis; Efficiency

JEL Classification: C10, C50, D24, L50.

Suggested Citation

Andor, Mark and Sommer, Stephan and Parmeter, Christopher, Combining Uncertainty with Uncertainty to Get Certainty? Efficiency Analysis for Regulation Purposes (October 9, 2018). USAEE Working Paper No. 18-361, Available at SSRN: https://ssrn.com/abstract=3263589

Mark Andor (Contact Author)

RWI – Leibniz Institute for Economic Research ( email )

Hohenzollernstr. 1-3
Essen, 45128
Germany

HOME PAGE: http://en.rwi-essen.de/mark-andor

Stephan Sommer

RWI - Leibniz-Institute for Economic Research ( email )

Hohenzollernstr. 1-3
Essen, 45128
Germany

Christopher Parmeter

University of Miami ( email )

Coral Gables, FL 33124
United States

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