UTILIZATION OF STUDENT’S T DISTRIBUTION TO HANDLE OUTLIERS IN TECHNICAL EFFICIENCY MEASUREMENT

Abstract

Stochastic frontier analysis (SFA) is the favorite method for measuring technical efficiency. SFA decomposes the error term into noise and inefficiency components. The noise component is generally assumed to have a normal distribution, while the inefficiency component is assumed to have half normal distribution. However, in the presence of outliers, the normality assumption of noise is not sufficient and can produce implausible technical efficiency scores. This paper aims to explore the use of Student’s t distribution for handling outliers in technical efficiency measurement. The model was applied in paddy rice production in East Java. Output variable was the quantity of production, while the input variables were land, seed, fertilizer, labor and capital. To link the output and inputs, Cobb-Douglas or Translog production functions was chosen using likelihood ratio test, where the parameters were estimated using maximum simulated likelihood. Furthermore, the technical efficiency scores were calculated using Jondrow method. The results showed that Student’s t distribution for noise can reduce the outliers in technical efficiency scores. Student’s t distribution revised the extremely high technical efficiency scores downward and the extremely low technical efficiency scores upward. The performance of model was improved after the outliers were handled, indicated by smaller AIC value.

Keywords

• cobb-douglas
• maximum simulated likelihood
• robust
• productivity
• sfa
• translog