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Measurement matters: Input price proxies and bank efficiency in Germany

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  • Koetter, Michael

Abstract

Most bank efficiency studies that use stochastic frontier analysis (SFA) employ each bank's own implicit input price when estimating efficient frontiers. But the theoretical foundation of most studies is a cost minimisation and/ or profit maximisation problem assuming perfect input markets. At the very least, traditional input price proxies therefore contain substantial measurement error. In this paper, we examine the magnitude and direction of this error in cost and profit efficiency (CE and PE) measurement. We suggest two input market definitions to approximate exogenous input prices alternatively and estimate CE and PE of German banks between 1993 and 2003. Our main findings are threefold. First, after accounting for systematic differences across banks, mean CE is sensitive to alternative input prices. Second, distortions of mean PE due to traditional input prices are small. Third, across CE models small cooperative banks located in large western states are identified as top performers. Large banks and those located in eastern states rank lowest.

Suggested Citation

  • Koetter, Michael, 2005. "Measurement matters: Input price proxies and bank efficiency in Germany," Discussion Paper Series 2: Banking and Financial Studies 2005,01, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdp2:4256
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    File URL: https://www.econstor.eu/bitstream/10419/19734/1/200501dkp_b.pdf
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    References listed on IDEAS

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    1. Falko Fecht & Kevin X. D. Huang & Antoine Martin, 2008. "Financial Intermediaries, Markets, and Growth," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 701-720, June.
    2. Hamerle, Alfred & Liebig, Thilo & Scheule, Harald, 2004. "Forecasting Credit Portfolio Risk," Discussion Paper Series 2: Banking and Financial Studies 2004,01, Deutsche Bundesbank.
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    Cited by:

    1. Hasan, Iftekhar & Koetter, Michael & Wedow, Michael, 2009. "Regional growth and finance in Europe: Is there a quality effect of bank efficiency?," Journal of Banking & Finance, Elsevier, vol. 33(8), pages 1446-1453, August.
    2. Taufiq Hassan & Shamsher Mohamad & Mohammed Khaled I. Bader, 2009. "Efficiency of conventional versus Islamic banks: evidence from the Middle East," International Journal of Islamic and Middle Eastern Finance and Management, Emerald Group Publishing, vol. 2(1), pages 46-65, April.

    More about this item

    Keywords

    Germany; Banks; cost efficiency; profit efficiency; stochastic frontier analysis; measurement error;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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