Nonparametric Methods to Measure Efficiency: A Comparison of Methods

Benjamin Hermalin

No 92-206, Economics Working Papers from University of California at Berkeley

Abstract: Using data on 951 savings and loans, we compare two nonparametric methods for measuring efficiency: Data Envelopment Analysis (DEA) and algebraic methods based on Varian (1984). We show that both methods are vulnerable to measurement error, although both theoretically and empirically we find the Varian-style measures to be less vulnerable. We also suggest simple methods to identify problematic observations and to reduce their influence on the results. Because we have data on the future insolvency of our savings and loans, we can directly compare the two methods by seeing which does a better job of predicting insolvency (working under the hypothesis that efficiency and insolvency should be negatively correlated). We find that the Varian-style methods do better; moreover, we find that some of the DEA measures yield the implausible result that efficiency and insolvency are positively correlated.

Date: 1992-12-01
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