Instrumental‐variable estimation of exponential‐regression models with two‐way fixed effects with an application to gravity equations

Koen Jochmans and Vincenzo Verardi

Journal of Applied Econometrics, 2022, vol. 37, issue 6, 1121-1137

Abstract: This paper introduces instrumental‐variable estimators for exponential‐regression models that feature two‐way fixed effects. These techniques allow us to develop a theory‐consistent approach to the estimation of cross‐sectional gravity equations that can accommodate the endogeneity of policy variables. We apply this approach to a dataset in which the policy decision of interest is the engagement in a free‐trade agreement. We explore ways to exploit the transitivity observed in the formation of trade agreements to construct instrumental variables with considerable predictive ability. Within a bilateral model, the use of these instruments has strong theoretical foundations. We obtain point estimates of the partial effect of a preferential‐trade agreement on trade volume that range between 20% and 30% and find no statistical evidence of endogeneity.

Date: 2022
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https://doi.org/10.1002/jae.2932

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Working Paper: Instrumental-Variable Estimation Of Exponential Regression Models With Two-Way Fixed Effects With An Application To Gravity Equations (2022)
Working Paper: Instrumental-Variable Estimation Of Exponential Regression Models With Two-Way Fixed Effects With An Application To Gravity Equations (2021)
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