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Solving the Puzzle: A New Measure of Trade Distance In The Gravity Equation

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  • Juan Felipe Mejía Mejía
  • Andrés Ramírez Hassan

Abstract

The gravity equation model is a workhorse tool that has been used many times in international trade. However, one philosophical and empirical question that arises when this theory is applied in this field is what is the relevant measure of distance. This question is easily solved in physics, which is the field where this theory was originally developed, but there is not clear answer in international trade. Therefore, we propose an index of distance based on principal component analysis that summarizes in one factor information related to geographical, cultural, political and economic variables that might affect international trade between countries. We use this index as proxy of distance, and Gross Domestic Product as proxy of mass, and we run some panel data exercises between 1995 and 2000 for 10 Latin American economies. Estimations indicate that the sign of the load factors in the principal component analysis are intuitively plausible, and that panel data exercises give sensible robust outcomes.

Suggested Citation

  • Juan Felipe Mejía Mejía & Andrés Ramírez Hassan, 2013. "Solving the Puzzle: A New Measure of Trade Distance In The Gravity Equation," Documentos de Trabajo de Valor Público 11556, Universidad EAFIT.
    • Handle: RePEc:col:000122:011556
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    More about this item

    Keywords

    Factor Analysis for Mixed Data; Gravity Equation Model; Panel Data; Trade Distance;
    All these keywords.

    JEL classification:

    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade

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