Efficiency Measurement Using a “True” Random Effects and Random Parameter Stochastic Frontier Models: An Application to Rural and Community Banks in Ghana

In this paper, we attempt to compare the results of stochastic frontier models that control for unobserved heterogeneity in the inefficiency model, and unobserved (parameter) heterogeneity in the production model respectively. We estimate a “true” random effect, and random parameter stochastic frontier models in a panel data framework. An application of these models is presented using data of rural and community banks in Ghana from 2006 to 2011. Our results show that the two models address the issue of unobserved heterogeneity, and therefore omitted unobserved heterogeneity in the production model may always show up in the estimated inefficiency.