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A stochastic frontier approach to modelling financial constraints in firms: An application to India

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  • Bhaumik, Sumon Kumar
  • Das, Pranab Kumar
  • Kumbhakar, Subal C.

Abstract

We propose the use of stochastic frontier approach to modelling financial constraints of firms. The main advantage of the stochastic frontier approach over the stylised approaches that use pooled OLS or fixed effects panel regression models is that we can not only decide whether or not the average firm is financially constrained, but also estimate a measure of the degree of the constraint for each firm and for each time period, and also the marginal impact of firm characteristics on this measure. We then apply the stochastic frontier approach to a panel of Indian manufacturing firms, for the 1997–2006 period. In our application, we highlight and discuss the aforementioned advantages, while also demonstrating that the stochastic frontier approach generates regression estimates that are consistent with the stylised intuition found in the literature on financial constraint and the wider literature on the Indian credit/capital market.

Suggested Citation

  • Bhaumik, Sumon Kumar & Das, Pranab Kumar & Kumbhakar, Subal C., 2012. "A stochastic frontier approach to modelling financial constraints in firms: An application to India," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1311-1319.
    • Handle: RePEc:eee:jbfina:v:36:y:2012:i:5:p:1311-1319
    DOI: 10.1016/j.jbankfin.2011.11.026
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    More about this item

    Keywords

    Firm investment; Financial constraint; Stochastic frontier analysis; India;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm

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