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Controlling for heterogeneity in gravity models of trade and integration

I-Hui Cheng () and Howard Wall ()

No 1999-010, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This paper compares various specifications of the gravity model of trade as nested versions of a general specification that uses bilateral country-pair fixed effects to control for heterogeneity. For each specification, we show that the a theoretical restrictions to obtain them from the general model are not supported statistically. Because the gravity model has become the ‘workhorse’ baseline model for estimating the effects of international integration, this has important empirical implications. In particular, we show that, unless heterogeneity is accounted for correctly, gravity models can greatly overestimate the effects of integration on the volume of trade.

Keywords: International; trade (search for similar items in EconPapers)
Date: 2004
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Published in Federal Reserve Bank of St. Louis Review, January/February 2005, 87(1), pp. 49-64

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