, Volume 6, Issue 3, pp 247-268

Estimators and hypothesis tests for a stochastic frontier function: A Monte Carlo analysis

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Abstract

This paper uses Monte Carlo experimentation to investigate the finite sample properties of the maximum likelihood (ML) and corrected ordinary least squares (COLS) estimators of the half-normal stochastic frontier production function. Results indicate substantial bias in both ML and COLS when the percentage contribution of inefficiency in the composed error (denoted by γ*) is small, and also that ML should be used in preference to COLS because of large mean square error advantages when γ* is greater than 50%. The performance of a number of tests of the existence of technical inefficiency is also investigated. The Wald and likelihood ratio (LR) tests are shown to have incorrect size. A one-sided LR test and a test of the significance of the third moment of the OLS residuals are suggested as alternatives, and are shown to have correct size, with the one-sided LR test having the better power of the two.

The author would like to thank Bill Griffiths, George Battese, Howard Doran, Bill Greene and two anonymous referees for valuable comments. Any errors which remain are those of the author.