Efficiency analysis in the presence of uncertainty

In a stochastic decision environment, di¤erences in information can lead rational decision makers facing the same stochastic technology and the same markets to make di¤erent production choices. E¢ ciency and productivity measurement in such a setting can be seriously and systematically biased by the manner in which the stochastic technology is represented. For example, conventional production frontiers implicitly impose the restriction that information di¤erences have no e¤ect on the way risk-neutral decision makers utilize the same input bundle. The result is that rational and e¢ cient ex ante production choices can be mistakenly characterized as ine¢ cient –informational di¤erences are mistaken for di¤erences in technical e¢ ciency. This paper uses simulation methods to illustrate the type and magnitude of empirical errors that can emerge in e¢ ciency analysis as a result of overly restrictive representations of production technologies.