Is Gravity Linear?

Daniel Millimet and Daniel Henderson ()

No 517, Departmental Working Papers from Southern Methodist University, Department of Economics

Abstract: Despite the solid theoretical foundation on which the gravity model of bilateral trade is based, empirical implementation requires several assumptions which do not follow directly from the underlying theory. First, unobserved trade costs are assumed to be a (log-) linear function of observables. Second, the ad-valorem tax equivalents of trade costs are predominantly assumed to be constant across space, and to a lesser extent time. Maintaining consistency with the underlying theory, but relaxing these assumptions, we estimate gravity models ?in levels and logs ?using two data sets via nonparametric methods. The results are striking. Despite the added flexibility of the nonparametric models, parametric models based on these assumptions offer equally or more reliable in-sample forecasts (sometimes) and out-of-sample forecasts (always), particularly in the levels model. Moreover, formal statistical tests fail to reject the theoretically consistent parametric functional form. Thus, concerns in the gravity literature over functional form appear unwarranted, and estimation of the gravity model in levels is recommended.

Keywords: Gravity Model; Bilateral Trade; Border Effect; Currency Union; Generalized Kernel Estimation (search for similar items in EconPapers)
JEL-codes: C14 C33 F14 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2006-04-05
New Economics Papers: this item is included in nep-for and nep-int
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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Journal Article: Is gravity linear? (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:smu:ecowpa:0517

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