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William H. GREENE
Cornell Uniwrsity, Ithacu, NY 14853, USA
1. Introduction
The estimation of production functions has been one of the more popular
areas of applied econometrics. Recent work in duality theory which has
linked production and cost functions has made this topic even more
attractive. Typically, least squares (or some variant, such as two stage or
generalized least squares) is used to estimate the model of interest in
accordance with the assumption of a normally distributed disturbance in the
model. However, definitions of a production function are given in terms of
the maximum output attainable at given levels of the inputs. Similarly, a
dual cost function gives the minimum cost of producing a given level of
output at some set of input prices [See Christensen and Greene (1976).] It
has thus been argued that the disturbances specified in these models, and
techniques used to estimate them should account for that fact. These
considerations have motivated the recent literature on frontier functions.
Numerous studies have been devoted to the respecification of empirical
production and cost models to make them more compatible with the
underlying theory, and to the derivation of appropriate estimators. In some
cases, this has amounted to minor modifications of least squares results. The
remaining estimators are based on two distinct specifications. The very recent
work on composite disturbances has relaxed somewhat the orthodox
interpretation of the underlying function as a strict frontier with all
observations lying on one side of it, and has produced well behaved
maximum likelihood estimators with all of the usual desirable properties.
Other authors, following the more strict interpretation, have employed what
we shall call full frontier estimators which allow only one sided residuals. It
*This is a revised version of an earlier paper, Cornell Working Paper no. 162. The helpful
comments of Henry Wan, Peter Schmidt, Jack Kiefer and two anonymous referees are gratefully
acknowledged.
28 WH. Greene, MLE of econometric frontier functions
has been shown that the received full frontier estimators are also maximum
likelihood. However, estimation of them has been something less than wholly
successful, due in large measure to the fact that, in spite of their being
maximum likelihood, their statistical properties are unknown.
The composite disturbance models offer an attractive specification.
However, they leave unanswered questions of the properties of full frontier
estimators, which do have a theoretical appeal. The purpose of this paper is
to provide some results on maximum likelihood estimation of full frontier
models. First, the common problems of the received estimators will be
analyzed. In short, as Schmidt (1975) points out, one of the standard
regularity conditions usually assumed in maximum likelihood estimation is
violated. For the frontier model, this means that the results usually invoked
for maximum likelihood estimators do not necessarily apply. An alternative
frontier estimator is then proposed. A class of probability distributions which
can be used for the disturbance model and which allow maximum likelihood
estimation to proceed as a regular case is defined. The statistical properties
of the resulting estimators are easily established using the standard results in
spite of the fact that this is a non-regular case. The results for a specific
disturbance formulation with some particularly convenient properties will be
examined in detail. Finally, the technique will be applied to two well known
sets of data.
y= Ax;x;~u, (2.1)
logy=logA+r,logx,+a,logx,-a, (2.2)
WH. Greene, MLE of econometricfrontierjiinctions 29
(2.4)
where pj is the unit price of xj, and C is total cost. Forsund and Jansen show
that maximum likelihood estimates are obtained using linear programming,
by minimizing the sum of positive residuals from the log of (2.7). Making the
transformation from u to a=log U- , we find
Equating 1 in (2.3) to (1 i-cc), we see that the stochastic framework here is the
same as that applied to ACs model.
This completes the list of the received full frontier maximum likelihood
estimators. In each case, estimates are obtained by solving a constrained
programming problem. The frontier model has been used to study the
structure of production and efficiency in production by a number of authors,
nearly all of whom have used the linear programming technique. The full
30 WH. Grrmr,MLE oleconornrtricfrontierfunctions
frontier model has the theoretical appeal of forcing the fitted function to
correspond to the underlying theory in terms of the signs of the residuals.
Moreover, they are maximum likelihood for certain stochastic specifications.
Unfortunately, certain problems have beset them. They can be highly
sensitive to outliers. To compensate for this problem, Timmer (1971)
proposed that the linear programming technique be modified to allow a
certain prespecified proportion of the residuals to have the wrong sign.
While this probably does solve the outlier problem, it must surely compound
the. statistical problems. The more serious shortcoming of these full frontier
estimators is their lack of identifiable statistical properties. Although they are
maximum likelihood, the characteristics of the estimation problem prevent us
from making any use of this result, except, perhaps, to justify the choice of
the computational algorithm. The observation that the programming
estimators are ML is not sufficient to enable us to establish their statistical
properties. No standard errors have been derived for them, and no statistical
inference based on them has been possible.
Beyond some cursory observations, we will not attempt to establish the
specific asymptotic properties of the programming estimators. This remains
for future research. We will, however, examine in some detail how the
problems with these models arise. In the process, the analysis suggests how
the problem of inference can be circumvented through the use of an
alternative estimator.
Without loss of generality, for the time being, x, will be assumed to have a
single element.
See, e.g., Christensen and Greene (1976, pp. 658%659), Zellner, Kmenta, and D&e (1966),
and Schmidt (1975, p. 238).
See Schmidts equation (3), but note the sign reversal in our formulation. Richmond (1974)
derives the same result for a specific disturbance model.
32 W.H. Greene, MLE of econometricfrontierfinctions
Assume, for example, that E has density in (2.3). This is easily shown to yield
fE(,)(E(l))=~Te-), which gives the exact results E(.s(i))=l/iT and V(E(~))
= 1/A2T2. Both of these vanish as T increases. Thus, for this case, a(,)
converges in mean square to 0, and y(i) = tl + ql) is consistent for c(.
3Note that a similar argument will establish the consistency of any order statistic of specific
rank, i.e., smallest, second smallest, 50th smallest (but not of any quantile in the sample). For
this reason, the efficiency of this estimator seems uncertain. Obviously, the bias of the sample
minimum is the smallest among the order statistics.
W.H. Greene, MLE of econometricfrontier functions 33
For the more general case in which fl #O, the simple result above cannot
be invoked. When B=O, although we cannot observe the disturbances, we can
observe their ranks. When there is a regressor in the model, so that we must
derive information about the disturbances from the residuals, even this
information is obscured. Let Zr=yl - bx,, where b is any consistent estimator
of p. (The intercept estimator has been discarded.) Note that et is the sample
estimate of I, =yt - ox,, but that while .Ct is observed, E, is not. Moreover,
(Ci,. . ., ET) is not a random sample as. the residuals are, in general, neither
independent nor identically distributed. Thus, the standard results for order
statistics do not apply here. Nonetheless, e(,, is a consistent estimate of c(
under the assumptions already made. (Our proof relies on the boundedness
of xt, and does not necessarily apply for cases in which x, is not restricted to
be finite for all t.)
&5F;+max(b-fl)x, Vt
Thus,
f f[ f
rninC?~~min E,+max(b-P)x,
1
qmin ~2,s min Et+ max (b - fl)x,
f t t
But, plim min, 1, =plim EC,,=u was proved above. Since x, is uniformly
bounded by Assumption 4, plim max, (b -p)x, =0 follows from the
consistency of b.
(*) :. plimEC,,sa.
&Z&+min(b--p)x, Vt.
t
34 W.H. Greene, MLE ofeconometricfrontier,functions
Thus
f *[ f
minE,zmin i?,+min(b-0)x,
1
*min e, 2 min E,+ min (b - P)x~
1 I r
Again, plim Ed,)= a; and plim min, (b - p)x, = 0 follows from the consistency of
b and from the assumption that x, is uniformly bounded.
(**) :. plim~~,,Zcx.
Since (*) and (**) must both be true, we have proved that plim&,=cc.
The conclusion is that regardless of the distribution of a,, if the sequence x,
is well behaved (as detined by our assumptions) and if the distribution of a,
meets the requirements above, then the OLS residuals can be used to derive
a consistent estimate of c(. We need only shift the intercept of the estimated
function until all residuals (save for the one support point) have the correct
sign. As before, ancillary parameters of the disturbance distribution can now
be consistently estimated using the moments of the observed residuals.
E[(l/T)dlogL/Z$]= (3.2a)
and
p -
- E[~I/T )a2 i0g L/a+a+q
1x
1 0
0 0 I 3
The extension is necessary because (J,, y2,. .,y.,.)do not constitute a random sample. While
independent (in most settings) the observations are not identically distributed; each has its own
mean. One approach is simply to consider repeated sampling of the multivariate observation
(p,lx,), t= l,..., T, as in Theil (1971, sec. 8.1). Alternatively, one can establish the necessary
results directly as do Barnett (1976) and Amemiya (1973).
36 W.H. Greene, MLE qfeconometric frontier,functions
(3.3a)
and
l/244
-E[(l/T)a* logL/a&%$] = ,,6/43 & 1/42 (3.3b)
(1) The parameter space @, which may be restricted, for example to exclude
non-positive variances, is compact and contains an open neighborhood
of the true value of q5, &.
(4) 2 logf(y,, $)/a$ has a positive definite variance matrix with finite
elements.
(5) The absolute value of the third derivatives of logf(yt,$) with respect to
4 are bounded by a bounded integrable function of y1 which does not
depend on 4.
(Note that the estimation problem defined here is a particularly well behaved
one.)
Now, by definition
~/(O)d~,=l,
I
so that
where L is the likelihood function, nr= 1 f(yt, qb), and Ego(. ) indicates that
the expectation is taken at the true parameter value. Similarly,
where f+ = af(y,,
4)/i@;and, interchanging again,
38 W.H. Grrune, MLE ofeconometricfrontierfunctio~s
and
(3.5)
With these results in hand, and with the other regularity conditions,
consistency, asymptotic efficiency, and asymptotic normality of the maximum
likelihood estimator can now be established [as, for example, in Kendall and
Stuart (1973, ch. 18)]. The negative of the inverse of E(a210gL/?@+)
provides the appropriate asymptotic covariance matrix for the maximum
likelihood estimator.
Independence of the range of yt of the parameters in 4 is normally
included among the regularity conditions in order to make the interchange of
integration and differentiation needed to establish (3.4) and (3.5) permissible.
In fact, given Condition 2, Condition 3 is not necessary but only sufficient.
The results in (3.4) and (3.5) can be established without Condition 3
provided other conditions are met.6 This has direct relevance for the
estimation of frontier functions, as this range problem is generally the only
one which prevents the likelihood function from being perfectly well behaved.
If we can establish (3.4) and (3.5) (or the necessary analog for the regression
case), then, in spite of this violation of the regularity conditions, the analysis
of Barnett or Amemiya for maximum likelihood estimation may be appealed
to directly to establish the properties of the MLE. (The simple regression
model generally considered in the frontier case is covered a fortiori by their
results for more involved cases.)
Suppose, then, that ,f(y,, 4) satisfies all of the regularity conditions except
that the range of J~depends upon 4. In particular, assume /(~)SY, su($). As
always,
In A, given Condition 2,
(3.6)
[A proof of this form of Leibnitzs rule may be found in e.g., Kaplan (1952,
p. 221).] The second and third terms after the first equality vanish when the range of
yr is independent of 4, as &($)/a$ = a/(4)/@ =O. However, they also
vanish whenf(u(~),~)=f(@),~)=O, even if the range of yt depends upon 4.
The requirement is simply that ,f(~,4) be zero at its terminal points.
Distributions for which this is the case are numerous. For example,
~~~~.~~(?-$)dy~=~~~~~m
(3.7)
If the derivatives of f(yt,4) with respect to 4 are zero when JJ~is at the upper
and lower terminal points of the distribution, then the operations of
differentiation and integration can again be interchanged. From here it is
straightforward to obtain (3.5). All of the familiar asymptotic properties for
maximum likelihood estimators can now be invoked directly, as the
assumption about the range of yt plays no further role. [See, for example,
Kendall and Stuart (1973, ch. IS).]
It remains to extend these results to the frontier function (regression) case.
Consider, then, a disturbance specification for the model (3.1) with
continuous p.d.f.f(s). Two sets of parameters will be involved here. First are
the ancillary parameters of the disturbance distribution, such as /z in (2.3);
second are the intercept and slopes of the frontier function. The range of y1 is
free of the first set. Maximum likelihood estimation of them presents no
unusual problems so long as f(s) is regular enough with respect to these
parameters, which we will assume. Hence, they will be ignored in what
follows with no loss of generality. Let 4 = (a, p). Then 1(+) =a +pxt, while u(4)
40 W.H. Greene, MLE ofeconomrtric frorttier functions
is irrelevant. Given J(E) and yt =tl +/?x, +E,, so that the Jacobian of the
transformation from E, to y1 is unity, we have
&(.L4)=f,(L-~(dJ)).
To establish (3.4) we need, from (3.6),
f(4,~)/,=,,~r=~(O)=o. (3.8)
This simply requires that the contact point of the disturbance distribution be
zero. Obviously, this does not hold for the exponential distribution for which
f,(O)=;l, nor for the half-normal distribution, for which f,(O)=2/&/%r. It
does hold, however, for the lognormal distribution. For (3.5) by (3.7), we
require
(3.9)
4. A disturbance specification
f(~)=G(~,P)=iP$-l
e=, EZO, 1>0, P>2. (4.1)
P(P)
The mean and variance of F are p = P/i and g2 = P/A. The presence of two
free parameters in f(e) obviates the possibly unwarranted assumption of a
functional relationship between p and 0 implicit in (2.3) and (2.4). For the
general case of G(& P), P must be positive. The restriction P> 2 gives (3.8)
and (3.9).
The log of the likelihood function for this disturbance model is
i;
The first derivatives
log L/an
of the log likelihood are
TP/l - 1 tzr
where et =yt - CI- /?xt and X is the (K x 1) column vector of sample means of
the K variables in x. With the exception of alog L/dP, it is simple to verify
E(dlogL/a$)=O.E(E)=P/~* and E(l/s)=i,/(P- 1) are found by direct
integration, from which E(dlog L/di,)=E(? log L/&)=E(dlog L/dfik)=O
follow directly. To find E(ln a), let v =/?a, so E(ln E) =E(ln tl) -In /1. The
distribution of v is easily shown to be G(l, P). While the distribution of In v
is messy, the cumulants of In v are simply K,(ln v) =dlnT(P)/dP. [Kendall
and Stuart (1973, p. 177).] In general, or =p and IC~=CT~. Thus, E(lnv)
=r(P)/T(P), and E(Z logL/dP)=O follows imediately. The second
derivatives of the log likelihood are
(P-1)1 (l/E:)X:X; J
(4.4)
where i is a column vector of ones, and the intercept has been included in
the vector of slopes. The only new result required to derive the exact
expectations for (4.4) is E( l/e:) = A/( (P - 1)(P - 2)). This gives
(4.5)
where
A = IA2 r=r(q,
-l//I
and
4, and 5) are easily verified. Thus, we will, at this point, invoke the results of
Cramer to assert the consistency asymptotic efficiency, and asymptotic
normality of the vector of parameter estimates 6 which maximize (4.2). The
limiting distribution of fi (&-4,) will be normal with mean 0 and
covariance matrix C-l, where Z=lim,,,C,; (l/T)C-, which we will
estimate by (l/T)f; , gives the asymptotic covariance matrix for 6.
The Gamma distribution is obviously asymmetric, hence maximum
likelihood estimation of the parameters in (4.2) should be more efficient than
least squares which takes no account of that fact. It will also, unlike OLS,
give a consistent estimate of CI. Ignoring, for now, the inconsistency of the
OLS intercept term, we would expect the gain in efliciency obtained by ML
to be related to the degree of skewness of the distribution. The skewness
coefficient, E(E-E(E))~/~ is readily shown to be 2/a. The parameter P is
clearly crucial. Intuitively, we might expect the greatest efficiency gain from
ML when P is small (near 2).
In fact, a more direct efficiency comparison is available. The exact variance
of the OLS estimator is, as always, a(X,X,)- = (P/E.2)(X;X,)) . The
lower right block of the inverse of TC, provides the basis upon which we
will estimate the asymptotic variance matrix of the maximum likelihood
estimator. As an initial approximation, assume TC, is block-diagonal. Then
the appropriate variance matrix is derived from ((P - 2)/A2)(X;X*)- 1 = ((P
-2)/P)a2(X;X,)- . Again, a small value of P will suggest a large efficiency
gain of ML over OLS. As a first guess, the number P/(P-2) should be
indicative of the relative asymptotic efficiency of ML over OLS for this
model. The limiting case of P=2 (which is inadmissable) results in a singular
second derivatives matrix, while large values of P imply no gain. In
accordance with the earlier result, large P implies a symmetric distribution.
Unfortunately, TC, will never be block diagonal, even if all regressors are
in deviation form, so long as there is an intercept in the model. The first row
of XLiS is T6 in every sample. Partitioning the inverse of TZ:,, we get
1
-1
(4.6)
This uses E(~)=r(P+r)/(lT(p)). Note that i has disappeared. This follows from the fact
that E is just (l/L)0 where u- G(l,P), and a constant scale factor will not affect the shape of the
distribution.
44 W.H. Greene, MLE qf econometric frontier functions
where
and
Y= (r(pr(p)- (~(p))2)l(~(p))2.
Consider the limiting cases P+2 and P+ cc. As P+2, p+O as does (P-2)/P,
and ST vanishes as before.8 As P+m, p+O again, while (P-2)/P-+1.
Maximum likelihood estimation provides no gain over OLS if the error
distribution in this model is symmetric. For the intermediate cases, we can
appeal to the usual results to assert the relative asymptotic efficiency of the
MLE.
For a final characterization of this distribution recall that E =v/A where v
y G(l,P). Now, let z= (a-E(u))/(T, = (v -P)/fi. The rth cumulant of z is
rc,(z)=pl-2 (rz2). As P+m, all cumulants except the second will go to
zero. (ICY=0 if ,U=O.) This sequence of cumulants characterizes the normal
distribution, so we may conclude that as P+co, z tends to standard
normality. As E is a linear transformation of z, we see that as P+co, the
distribution of E tends to normality. This implies that the maximum
likelihood estimator should approach the ordinary least squares estimator.
This last property makes the gamma density extremely attractive for
estimating the production or cost frontier, as it implies that the model is
quite flexible in the shapes of error distributions it will accommodate.
Suppose the process generating the disturbances is such that the error
distribution is symmetric, or nearly so. Our consistent estimate of (c(,p) will
allow us to discern this from the regression residuals. The maximum
likelihood estimate of P will tend to be.large, while i will adjust to place the
mean in the appropriate location. Moreover, the slope estimators should
resemble the OLS estimators in value and efftciency, while the intercept term
will now be a consistent estimate of c(. Alternatively, if the observations tend
to be grouped close to the frontier, with only a relatively small number in
the extreme range, then P should be small, the error distribution will be
highly skewed, and we should expect the maximum likelihood estimator to
be highly efficient relative to OLS.
This has an implication for the average versus frontier estimators
discussed in a number of studies. The average estimator is generally
This requires that (Py- 1) not go to zero. But (Py- I )= (r2/T)lAl, which must be positive for
all P greater than 0. [Consider the asymptotic variance matrix of the MLE for (i,P) based on
an observed sample of cs, This would be A-, which must be positive definite.]
Kendall and Stuart (1968, pp. 47, 68, 94-101, 136, 166-167).
W.H. Greene, MLE of econometric frontier functions 45
P(P) z f r,P),
vi h(wi,
i=l
where h(wi, r, P) = wp- (log wi)*, and vi and wi are the Gauss-Laguerre
polynomial weights. [See IBM (1977, pp. 303-307).] The constraints P>2
and ;I > 0 were imposed by the method of squaring. The parameters P and A
in (4.2) were replaced by (Pi +2) and Ai; then (4.2) was maximized with
respect to P, and A.+without constraints.
In the iterative procedure, a slight modification of the scoring algorithm
was necessary. The procedure would normally be &+ ) = $) + d(), where
d)= -H(s)-gs), HCs) is the inverse of (4.5), and g) is the current value of
(4.3). However, the direction vector, d, was quite large in the early iterations,
so the process became unstable. To compensate, the elements of (AZ/p
- 2)Sx;x* in (4.5) were multiplied by T prior to inversion. This
substantially reduced the size of d at each iteration, and resulted in extremely
slow convergence of the process. However, the computations at each
iteration are simple, and even excessive numbers of iterations are quite
inexpensive. The process was stopped when the relative change in the
likelihood function was less than O.OOOO1.lo
Starting values for the intercept and slopes were the modified ordinary
least squares values of section 3.1. The intercept must be moved slightly
further than this procedure dictates in order to insure that no residual be
zero. The modified set of residuals now has mean C and (unchanged)
variance s2, both positive. Since E(E) =P/A and V(E) = P/,i2, appropriate
consistent starting values for P and A are P22/s2 and FJs2, respectively. The
starting value for A is obviously positive, and the starting value for P was
well over 2 in every case attempted.
For the function in the second application, with 5 parameters in addition to P and E.,
convergence required about 220 iterations, but less than eight seconds of CPU time on an IBM-
370. All computations were done in double precision.
This does not necessarily produce p>2. In all applications considered, however, i, was
greater than 5. It is easy to see, though, that P will almost surely be greater than 2 in any
sample. The modified set of OLS residuals is obtained by shifting the intercept until every
residual is positive, Let e,i, be the minimum of the original OLS residuals, Then e,i, must be less
than 0. The mean of the modified residuals is simply --e,,,, while the variance remains .s2. Thus.
~=c:,,/.s, The requirements P>2 is equivalent to e(,,/ s < - 1.4142. We require that the smallest
OLS residual in the sample be at least 1.4142 standard deviations below 0, an event which is
extremely likely in any sample, and has probability approaching 1 as T+ x
W.H. Greene, MLE of econometric frontier functions 41
5. Applications
Two data sets will be analyzed to illustrate the estimation of the frontier
function. To provide a comparison with some prior results, the production
frontier estimated by Aigner and Chu and by Aigner, Lovell, and Schmidt
will be reestimated using the technique of section 4. The second application
will involve a dual cost function. Finally, we will consider the question of
estimating technical efficiency using the frontier estimates.
The AignerXhu study uses statewide data on the U.S. primary metals
industry (SIC 33) to estimate the parameters of a Cobb-Douglas production
function,
where I/ is value added, L is labor input, K is the gross book value of plant
and equipment, and R is the ratio of net to gross book value of plant and
equipment. Value added, labor, and capital are computed on a per
establishment basis, and there are 28 statewide observations in the sample.
[These data were first analyzed by Hildebrand and Liu (1965).]
Aigner and Chu estimated the parameters of (5.1) using linear
programming (LP) and quadratic programming (QP). These estimators are
maximum likelihood for the exponential distribution and half-normal
distribution, respectively. In their recent, innovative paper, Aigner, Love11
and Schmidt (ALS) respecified the disturbance, E, to be equal to (tl-u),
where u is assumed to be normally distributed with mean zero and variance
at, while u has the half normal distribution in (2.3) Thus, E has an
asymmetric distribution. The symmetric disturbance, v, is assumed to be due
to uncontrollable factors such as weather, making the effective frontier,
c(+/Yx+ c, stochastic. The negative term, -u, is assumed to be due to
inefficiency.
Table 1 presents the parameter estimates obtained using five estimators,
OLS, LP, QP, maximum likelihood for the stochastic frontier, and
maximum likelihood for the full frontier using the Gamma density.13
Numbers in parentheses below certain of the estimators are asymptotic t-
ratios computed using the ratio of the estimate to the square root of the
appropriate diagonal element of the estimated asymptotic covariance matrix.
They also consider the case in which u has the exponential distribution. See also Meeusen
and van den Broeck (1977).
13The first four of these are taken from Aigner, Lovell, and Schmidt (1977, p. 32).
48 W.H. Greene, MLE qf econometric~rontier functions
While the stochastic frontier function is quite close to the OLS estimator,
the full (gamma) frontier is substantially different. ALS deduce the first of
these comparisons from the very small value of 0, which suggests that their E
is dominated by the symmetric normal error term. Thus, the resemblance to
Table 1
Estimates of eq. (5.1).
& 131. 8, 1 B
0.0707
; -0.0122 0.0048
ii: o.OQOO1 -0.0011 0.00011
a a
,I ~ 0.0061 11.0301
a a 2.045X
B - 0.0048 4.5273
OLS is to be expected. The results for the gamma function are in strong
disagreement. The value for P of 5.3804 is rather small, giving a skewness
coefficient of 0.8622. By comparison, the skewness for ALSs distribution is
only 0.000068.14 As expected, the gamma parameter estimates are quite
different from OLS and the ALS estimates. The large efficiency gains
predicted by the small value of P can be seen in the substantially larger f-
ratios. If anything, the first guess efficiency ratio of 1.59 .understates the
difference.
where K, I,, and F are inputs of capital, labor and fuel respectively. The
implied underlying production function is homothetic, but not homogeneous.
[See Christensen and Greene (1976, pp. 661, 665).] The linear homogeneity
in prices constraint has been imposed, and E, is assumed to be greater than 0
in the current setting. The implied scale economies parameter is
%ee Diewert (1974) and Shephard (1953) for proofs of these results
50 W.H. Greene, MLE qfeconometric frontier functions
which clearly varies with yr as desired. Note that v1 is the ratio of average to
marginal cost.
Several estimates of (5.2) are presented in table 2. First, the OLS and
modified OLS results (per section 3) are given. Second, the multivariate
regression results obtained by maximum likelihood estimation (assuming
multivariate normality, MLMN) of the system of equations (5.2) and the
factor share equations,
are given along with the intercept correction. Finally, the frontier estimator
using the gamma distributed error term (MLG) is presented.16
There is a surprising pattern in the parameter estimates. The estimates of
the price terms, 0, and 0, using the frontier estimator are very similar to the
OLS results. The large differences in the MLMN estimates are obviously due
to the information in the share equations used by this estimator. The mean
sample values of capitals and labors share in total cost are 0.439 and 0.106,
respectively. As might be expected, the efficiency of the full information
estimator of these parameters far exceeds that of either single equation
estimator. The output terms behave quite differently. Both MLG estimates
are very close to midway between *the OLS and MLMN estimates, an
outcome which is somewhat surprising in view of the relatively large value of
P obtained. As before, noticeable gains in efficiency over OLS are obtained.
The frontier estimator performs about as well as MLMN on the output
terms, but generally worse on the price terms. Estimates of the mean and
variance (both empirical and implied for the MLG case) of the disturbance
distribution are presented with each set of estimates. Again, the MLG results
more closely resemble OLS.
The relative similarity of the MLG results to OLS might have been
predicted on the basis of the large estimate of P. Table 3 gives a comparison
of the distributions of c estimated for the production and cost frontiers. The
efficiency ratio p./(p-2) is far less for the cost case. The skewness coefficient
is much smaller, indicating a more nearly symmetric error distribution. As a
final measure, the degree of excess, E(E -~)~/a~ - 3 is computed. For the
See Christensen and Greene (1976) for details on the MLMN estimator. The third factor
share is redundant due to the adding up condition, and is dropped. Also, one of Nerloves
observations appears to be inappropriate for the sample. The sample is of the, costs of steam
power generation for 145 firms, but his observation 6 has costs only 10% to 25?:, of that of
comparably sized firms. However, most of this companys capacity was hydraulic, which would
greatly reduce the costs of thermal generation. This observation was dropped in calculating the
frontier estimator. All results are based on the reduced sample of 144 observations.
W.H. Greene, MLE of econometric frontier functions 51
Table 2
Estimates of eq. (5.2).
A= 14.860, p = 17.072
(8.49) (3.66)
PIi= 1.149, I?jK2 = 0.077
(58.32) (5.88)
aThe t-ratio for the modified intercept will not quite equal that of the original estimate, since
V(jO)# V(fl,+e,,,). It is not clear what standard error is appropriate, although the original
estimate should be a good approximation.
Table 3
Summary statistics for production and cost frontier disturbance distributions
B 5.3804 17.0716
Asymptotic efficiency ratio 1.5916 1.1327
Skewness 0.8662 0.4841
Degree of excess 1.1152 0.3083
Table 4
Estimates of scale economies
Output
(million k Wh) OLS MLMN MLG
The scale economies results for the three estimators are very similar in
spite of the differences in the parameter estimates. Table 4 presents the value
of ylt for the firm with the median output in each live groups. (The firms are
ranked by output and there are 29 firms in each group.) The frontier does
predict that scale economies are slightly more persistent than suggested by
the other two estimators. The predicted minimum efficient scale (MES), at
which average cost reaches its minimum, is larger for the frontier, although
the difference is certainly not economically meaningful.
E(e-)=[i/l+rIjP, (5.3)
and
Table 5
Efficiency distributions
Production cost
A 11.1931 14.8600
P 5.3804 17.072 1
Gamma density (E)
Mean 0.4562 1.149
Standard deviation 0.1967 0.2715
Efficiency distribution (u)
Mean 0.6454 3.2849
Standard deviation 0.1182 1.0028
Implied dual efftciency distribution (a)
a
Mean 1.4827
a
Standard deviation 0.2146
Consider, for example, a sample of 1 from the model y=cr ts and B- G( 1,3). Any
programming estimator will choose &=y and e=O, but the MLE will be 4=).-Z and e=2.
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