Empirical estimation of production risk using a cost function with panel data

Abstract

The purposes of this study are twofold. First, it extends production risk from a production function to a more general cost function. The theoretical model is able to account for the effects of risk on a firm's minimum cost and optimal input demands. Second, the present paper provides an estimable framework for an analysis of the impacts of the risk on firm behaviour. Employing the model to Taiwan's electronics and information industry, it is found that production risk appears to play an important role in production cost. Evidence is found that the vast majority of sample firms belong to risk-averters.

Acknowledgements

Financial support from the National Science Council, Executive Yuan, Taiwan, Republic of China, is gratefully acknowledged.

Notes

¹ It is evident that if α > 0.5, then term (1 + R) is greater than unity. This appears to be incorrect, because the satisfaction of the constraint y ≤ (1 + R) f (X) implies that a firm's actual level of output y must exceed its production frontier f (X).

² Batra and Ullah (1974), Hartman (1975), and Robison and Barry (1987, chapter 9) reached similar conclusions under output price uncertainty.

³ It can be seen that there is no way in which α₀ and R can be estimated separately and achieve consistent estimates, without imposing additional restrictions.

⁴ Notation ‘⁁’ means an estimator of the corresponding parameter.