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Modeling and Estimation of Gravity Equation in the Presence of Zero Trade: A Validation of Hypotheses Using Africa's Trade Data

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  • Kareem, Fatima O.
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    Abstract

    Gravity model of trade has emerged as an important and popular model in explaining and predicting bilateral trade flows. While the theoretical justification is no longer in doubt, nonetheless, its empirical application has however generated several unresolved controversies in the literature. These specifically concerns estimation challenges which revolve around the validity of the log linear transformation of the gravity equation in the presence of heteroscedasticity and zero trade observations. These two issues generate several challenges concerning the appropriate choice of the estimation techniques. This paper evaluates the performance of alternative estimation techniques in the presence of zero trade observations, checks for the validation of their assumptions and their behaviour in cases of departure from their assumptions, particularly the departure from the heteroscedasticity assumption. Analysis was based on a dataset of Africa's fish exports to the European Union, which contains about 70% zero observations. Given our dataset and the gravity equation specified, our results show that there is no one general best performing model, although most of the linear estimators outperform the GLM estimators in many of the robust checks performed. In essence, we find that choosing the best model depends on the dataset, and a lot of robust tests and advocate an encompassing toolkit approach of the methods so as to establish robustness. We concur with Head and Mayer (2013) that the gravity equation is indeed just a toolkit and cookbook in the estimation of bilateral trade flows.

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    Bibliographic Info

    Paper provided by European Association of Agricultural Economists in its series 140th Seminar, December 13-15, 2013, Perugia, Italy with number 163341.

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    Date of creation: 2014
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    Handle: RePEc:ags:eaa140:163341

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    Keywords: Gravity Equation; Heteroscedasticity; Zero trade flows; Estimation techniques; Agribusiness; C13 C33 F10 F13;

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    1. Leamer, E. & Levingsohn, J., 1994. "International Trade Theory: The Evidence," Working Papers 368, Research Seminar in International Economics, University of Michigan.
    2. Elhanan Helpman & Marc Melitz & Yona Rubinstein, 2008. "Estimating Trade Flows: Trading Partners and Trading Volumes," The Quarterly Journal of Economics, MIT Press, vol. 123(2), pages 441-487, 05.
    3. Bergstrand, Jeffrey H, 1985. "The Gravity Equation in International Trade: Some Microeconomic Foundations and Empirical Evidence," The Review of Economics and Statistics, MIT Press, vol. 67(3), pages 474-81, August.
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    8. Anderson, James E, 1979. "A Theoretical Foundation for the Gravity Equation," American Economic Review, American Economic Association, vol. 69(1), pages 106-16, March.
    9. Inmaculada Martínez-Zarzoso, 2013. "The log of gravity revisited," Applied Economics, Taylor & Francis Journals, vol. 45(3), pages 311-327, January.
    10. James E. Anderson & Eric van Wincoop, 2003. "Gravity with Gravitas: A Solution to the Border Puzzle," American Economic Review, American Economic Association, vol. 93(1), pages 170-192, March.
    11. J. M. C. Santos Silva & Silvana Tenreyro, 2009. "Trading Partners and Trading Volumes: Implementing the Helpman-Melitz-Rubinstein Model Empirically," CEP Discussion Papers dp0935, Centre for Economic Performance, LSE.
    12. Andrew K. Rose & Eric van Wincoop, 2001. "National Money as a Barrier to International Trade: The Real Case for Currency Union," American Economic Review, American Economic Association, vol. 91(2), pages 386-390, May.
    13. Feenstra, Robert & Markusen, James R. & Rose, Andrew K, 1998. "Understanding the Home Market Effect and the Gravity Equation: The Role of Differentiating Goods," CEPR Discussion Papers 2035, C.E.P.R. Discussion Papers.
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