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Joint estimation of the Lerner index and cost efficiency using copula methods

Author

Listed:
  • Tai-Hsin Huang

    () (National Chengchi University)

  • Nan-Hung Liu

    () (National Chengchi University)

  • Subal C. Kumbhakar

    () (State University of New York)

Abstract

Abstract This paper deals with the estimation of market power, measured by the Lerner index, and cost efficiency at the bank level, using the stochastic frontier (SF) methodology. Both market power and cost efficiency are estimated jointly in a single step. We use the copula method to incorporate dependence between market power and cost efficiency. In contrast to earlier works that used a two-step approach, the SF approach used herein estimates a bank-specific nonnegative Lerner index free from random shocks. We showcase the advantages of our proposed methodology in terms of an empirical study on the banking sectors of five former communist countries during the period 2000–2008. Compared to the conventional approach, our model gives higher mean values of the Lerner index and smaller standard deviations. Further, we find a significant positive relationship between cost efficiency and market power of banks, thereby rejecting the “quiet life hypothesis.”

Suggested Citation

  • Tai-Hsin Huang & Nan-Hung Liu & Subal C. Kumbhakar, 2018. "Joint estimation of the Lerner index and cost efficiency using copula methods," Empirical Economics, Springer, vol. 54(2), pages 799-822, March.
  • Handle: RePEc:spr:empeco:v:54:y:2018:i:2:d:10.1007_s00181-016-1216-z
    DOI: 10.1007/s00181-016-1216-z
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    More about this item

    Keywords

    Copula methods; Cost efficiency; Lerner index; Market power; Quiet life hypothesis;

    JEL classification:

    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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