Stochastic frontier models

The stochastic frontier model was first proposed in the context of production function estimation to account for the effect of technical inefficiency. The inefficiency causes actual output to fall below the potential level (that is, the production frontier) and also raises production cost above the minimum level (that is, the cost frontier). Recent applications of the model are found in many fields of study including labour, finance, and economic growth. In these applications, the observed outcome (of wages, investment, and so on) is modelled as being deviating from a frontier level in one direction owing to factors such as information asymmetry.