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The Log of Gravity

João Santos Silva () and Silvana Tenreyro ()

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: Although economists have long been aware of Jensen's inequality, many econometric applications have neglected an important implication of it: the standard practice of interpreting the parameters of log-linearized models estimated by ordinary least squares as elasticities can be highly misleading in the presence of heteroskedasticity. This paper explains why this problem arises and proposes an appropriate estimator. Our criticism to conventional practices and the solution we propose extends to a broad range of economic applications where the equation under study is log-linearized. We develop the argument using one particular illustration, the gravity equation for trade, and apply the proposed technique to provide new estimates of this equation. We find significant differences between estimates obtained with the proposed estimator and those obtained with the traditional method. These discrepancies persist even when the gravity equation takes into account multilateral resistance terms or fixed effects

Keywords: Elasticities; Gravity equation; Heteroskedasticity; Jensens inequality; Poisson regression; Preferential-trade agreements (search for similar items in EconPapers)
JEL-codes: C13 C21 F10 F11 F12 F15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm and nep-int
Date: 2005-07
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Journal Article: The Log of Gravity (2006) Downloads
Working Paper: The Log of Gravity (2005) Downloads
Working Paper: The log of gravity (2005) Downloads
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