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Gravity with granularity

Holger Breinlich, Harald Fadinger, Volker Nocke and Nicolas Schutz

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: We evaluate the consequences of oligopolistic behavior for the estimation of gravity equations for trade flows. With oligopolistic competition, firm-level gravity equations based on a standard CES demand framework need to be augmented by markup terms that are functions of firms' market shares. At the aggregate level, the additional term takes the form of the exporting country's market share in the destination country multiplied by an exporter-destination-specific Herfindahl-Hirschman index. For both cases, we show how to construct appropriate correction terms that can be used to avoid problems of omitted variable bias. We illustrate the quantitative importance of our results for combined French and Chinese firm-level export data as well as for a sample of product-level imports by European countries. Our results show that correcting for oligopoly bias can lead to substantial changes in the coefficients on standard gravity regressors such as distance or the impact of currency unions.

Keywords: gravity equation; oligopoly; CES demand; aggregative game (search for similar items in EconPapers)
JEL-codes: F12 F14 L13 (search for similar items in EconPapers)
Date: 2021-03-15
New Economics Papers: this item is included in nep-bec and nep-int
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Working Paper: Gravity with granularity (2021) Downloads
Working Paper: Gravity With Granularity (2020) Downloads
Working Paper: Gravity with Granularity (2020) Downloads
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