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The random parameters stochastic frontier cost function and the effectiveness of public policy: Evidence from bank restructuring in Mexico

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  • Barros, Carlos Pestana
  • Williams, Jonathan
Abstract
We apply specifications of the random parameters stochastic frontier cost function model to estimate bank efficiency. This class of model appears to resolve the long standing problem of confounding inefficiency and heterogeneity. Mean cost efficiencies from random models are higher by as much as eleven percentage points compared to pooled OLS estimates. Whilst tests show efficiencies are not drawn from the same population, rank order efficiencies are strongly associated. In a second step, we employ the estimated efficiencies to determine the effect of foreign acquisitions on bank cost efficiency following legislative reforms made as part of Mexico's bank restructuring programme in 1995. Foreign bank acquisition does not significantly affect efficiency whereas consolidation of local banks yields significant long-term improvements in efficiency. We recommend random parameters stochastic frontier models since they better accommodate heterogeneity and produce more precise estimated efficiencies.

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  • Barros, Carlos Pestana & Williams, Jonathan, 2013. "The random parameters stochastic frontier cost function and the effectiveness of public policy: Evidence from bank restructuring in Mexico," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 98-108.
    • Handle: RePEc:eee:finana:v:30:y:2013:i:c:p:98-108
    DOI: 10.1016/j.irfa.2013.06.006
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    More about this item

    Keywords

    Mexico; Banks; Stochastic frontier; Random parameters; Efficiency; Foreign banks;
    All these keywords.

    JEL classification:

    • C2 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance

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