Maximum Likelihood Estimation of Censored Stochastic Frontier Models: An Application to the Three-Stage DEA Method

This paper takes issues with the appropriateness of applying the stochastic frontier analysis (SFA) technique to account for environmental effects and statistical noise in the popular three-stage data envelopment analysis (DEA). A correctly specified SFA model with a censored dependent variable and the associated maximum likelihood estimation (MLE) are proposed. The simulations show that the finite sample performance of the proposed MLE of the censored SFA model is very promising. An empirical example of farmers’ credit unions in Taiwan illustrates the comparison between the censored and standard SFA in accounting for environmental effects and statistical noise.