Effects of Heterogeneity on Measuring Efficiency Scores : The Case of China's Banking Sector

This study aims to investigate the significance of adequately accounting for heterogeneity in banking efficiency. It compares different specifications of stochastic cost frontier models which attempt to account for bank heterogeneity in various ways. This study compares the estimated parameters from five different specifications, conducts a specification test and discusses the effect of accounting for the heterogeneity on efficiency scores and rankings. The findings indicate that heterogeneity across banks could influence production directly, through the cost frontier, or indirectly through its effect on efficiency. This study concludes that accounting for the heterogeneity in the sample of Chinese banks is an important issue which, if not taken into account, may lead to biased estimates of banking efficiency