Kuala Lumpur Stock Exchange Traded Bank Performance with Stochastic Frontiers

Introduction

Stock market's performance is generally affected by many different factors which include economic and political environment in the country, interest rate movement, liquidity or the movement in money supply in the economy. This makes the economic performance of a country the most fundamental factor that determines the performance of a particular stock market. All these macro and micro factors that are interrelated because, exerting their influence on the performance and profitability of individual banks affect their stock prices in the market. Banks traded on stock market plays an important role in the economic development based on their performance. Failure to do some satisfactory performance may damage the bank’s reputation leading to a customer’s defections and breakdowns with other key stakeholders, such as deterioration or loss of investor confidence in management. The absence of efficiencies creates instability that causes the barrier in the development of any economy. Therefore, an effort is necessary to investigate bank’s efficiency traded on stock market by using parametric frontier technique considering the importance of the financial system in attaining the performance with changes in the regulatory environment and globalization of financial markets.

Despite a substantial of literature on banking efficiency, no studies were attempted to investigate the efficiency of banks traded in Kuala Lumpur stock Exchange (KLSE) market except the study of Hasan et al. (2012). The present study is an extension of Hasan et al. (2012) and this study covers almost all banks traded in KLSE in Malaysia. Motivated by the limited research in theoretical stochastic frontier model for banking traded in KLSE market, this study discovers stock market oriented bank performance stochastic frontier model by introducing Stochastic Frontier Analysis (SFA). SFA is considered in this study to measure the technical efficiencies of sampled banks in KLSE market in Malaysia instead of Data Envelopment Analysis (DEA) because of its’ advantages in dealing with stochastic noise and allows statistical tests of hypotheses concerning production structure and degree of inefficiency. DEA does not impose any assumptions about production functional form and does not take into account a random error (Kasman & Turgutlu, 2007). The addition of a variable in the DEA model leads to an extra constraint, which affects the DEA efficiency results, even though the added variable may be statistically insignificant in the SFA model. Most previous studies used the half-normal and truncated normal distribution as an assumption on the inefficiency effects model because of the ease of estimation and interpretation (Kirkley et al., 1995). Based on the Likelihood-Ratio test, this study will determine whether half-normal or truncated normal is preferable.

This study attempts to fill the gap in existing literature with SFA model performance measurement for the listed banks in KLSE market namely Bursa Malaysia. This study has the following specific objectives: (1) Selecting the appropriate stochastic frontier model for KLSE traded bank performance, (2) Determining the stochastic frontier measures on market return, market capitalization and book to market ratio, (3) Testing whether there is a significant difference among bank technical efficiency scores, and (4) Testing whether KLSE traded bank inefficiency effects model follows half-normal distribution. In addition, this study provides significant empirical contributions to performance literature in general and it will offer specific managerial implications that can be helpful in the decision making of financial banks in KLSE.