Measuring E¢ ciency: A Kalman Filter Approach

In the Kalman …lter setting, one can model the disturbance term and the ine¢ ciency term of the standard stochastic frontier composed error as unobserved states. This gives signi…cant ‡exibility to the econometrician when modeling ine¢ ciency. In this study a panel data version of the local level model is used for estimating time-varying e¢ ciencies of …rms. Monet Carlo simulation results indicate that whenever the e¢ ciency levels of the …rms ‡uctuate, some of the widely used estimators perform poorly in capturing the e¢ ciencies of the …rms. On the other hand, the Kalman …lter performs quite well. We apply the Kalman …lter to estimate average e¢ ciencies of U.S. airlines during the period 1999-2009 and …nd that the technical e¢ ciency of these carriers do not show a tendency to increase. For the …rst few years of the study period, it seems that the e¢ ciencies of the airlines decreased.

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