Uncertainty, Risk Premium, and Productivity in the Taiwan Banking Industry

In this paper, we formulate a behavioral model under uncertainty to estimate the total factor productivity in the Taiwan banking industry. In particular, the paper provides a model based on the safety-first rule under uncertainty to measure the risk premium in banking operations that are subject to loan default and other investment risks. Using panel data of forty banks in 1981-1996, a translog cost function and the associated share equations are used to estimate the dual rate of total cost diminution, the dual returns to scale, and the derived primal rate of total factor productivity. A constant elasticity of transformation output function is employed to construct an aggregated output index of loan and investment activities. The empirical results indicate a zero productivity growth and a highly risk averse banking industry. Government-owned banks are generally more risk averse than privately owned banks. As expected, the Taiwan banking industry became more risk venturesome after the deregulation and liberalization of the industry and during the stock market boom of late 1980s.