A decomposition of profit inefficiency into price expectation error, preferences towards risk and technical inefficiency

The paper addresses the decomposition of firms’ profit inefficiency (i.e. the difference between the observed profit and the maximal profit that could have been earned) in a context of output price uncertainty. More precisely, we separate this inefficiency into price expectation error, expected profit loss due to risk preference and technical inefficiency. Within this decomposition, the allocative inefficiency is explicitly defined as the result of price expectation error and risk attitude instead of being a residual (as in the traditional profit inefficiency decomposition). Our theoretical model is then implemented in a Data Envelopment Analysis framework which allows the separate estimation of each term of the decomposition. Besides, we offer an operational tool to reveal producers’ risk preferences and to measure their intensity. While the DEA approach is appealing since it imposes very few assumptions on the production set, its main drawback lies in the sensitivity of the measure to outliers. We therefore adapt our model to a robust approach.