Abstract
This paper estimates a stochastic profit system, which includes technical and allocative inefficiencies, in order to identify the source of profit inefficiency. Previously, the estimation of a stochastic profit system was not fully successful due to the entanglement of parameterised inefficiencies with a random error. We solve the problem by using homogeneity in technology since homogeneity enables a profit function to be separable into two parts: an output and a normalised profit function in which the parameter of technical inefficiency is absent. We apply our method to the Korean savings banks.
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