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Estimation of the Gravity Equation in the Presence of Zero Flows

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Author Info
Gert-Jan M. Linders () (Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam)
Henri L.F. de Groot () (Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam)

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Abstract

The gravity model is the workhorse model to describe and explain variation in bilateral trade patterns. Consistent with both Heckscher-Ohlin models and models of imperfect competition and trade, this versatile model has proven to be very successful, explaining a large part of the variance in trade flows. However, the log-linear model cannot straightforwardly account for the occurrence of zero-valued trade flows between pairs of countries. This paper investigates the various approaches suggested to deal with zero flows. Apart from the option to omit the zero flows from the sample, various extensions of Tobit estimation, truncated regression, probit regression and substitutions for zero flows have been suggested. We argue that the choice of method should be based on both economic and econometric considerations. The sample selection model appears to fit both considerations best. Moreover, we show that the choice of method may matter greatly for the results. In the end, the results surprisingly suggest that the simplest solution, to omit zero flows from the sample, often leads to acceptable results, although the sample selection model is preferred theoretically and econometrically.

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Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 06-072/3.

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Date of creation: 14 Aug 2006
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Handle: RePEc:dgr:uvatin:20060072

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Related research
Keywords: bilateral trade; gravity model; zero flows; sample selection model;

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Find related papers by JEL classification:
F14 - International Economics - - Trade - - - Country and Industry Studies of Trade
F15 - International Economics - - Trade - - - Economic Integration

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References listed on IDEAS
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  15. Buch, Claudia M. & Kleinert, Jorn & Toubal, Farid, 2004. "The distance puzzle: on the interpretation of the distance coefficient in gravity equations," Economics Letters, Elsevier, vol. 83(3), pages 293-298, June. [Downloadable!] (restricted)
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  16. Soloaga, Isidro & Alan Wintersb, L., 2001. "Regionalism in the nineties: what effect on trade?," The North American Journal of Economics and Finance, Elsevier, vol. 12(1), pages 1-29, March. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Mitze, Timo & Alecke, Björn & Untiedt, Gerhard, 2008. "Trade, FDI and Cross-Variable Linkages: A German (Macro-)Regional Perspective," MPRA Paper 12245, University Library of Munich, Germany. [Downloadable!]
  2. Cipollina, Maria & Salvatici, Luca, 2007. "EU and developing countries: an analysis of preferential margins on agricultural trade flows," Working Papers 7219, TRADEAG - Agricultural Trade Agreements. [Downloadable!]
  3. Vollrath, Thomas L. & Hallahan, Charles B., 2009. "Economic costs and payoffs of bilateral/regional trade agreements," 2009 Annual Meeting, July 26-28, 2009, Milwaukee, Wisconsin 49375, Agricultural and Applied Economics Association. [Downloadable!]
  4. Timo Mitze & Björn Alecke & Gerhard Untiedt, 2009. "Trade-FDI Linkages in a System of Gravity Equations for German Regional Data," Ruhr Economic Papers 0084, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen. [Downloadable!]
  5. Luigi Guiso & Paola Sapienza & Luigi Zingales, 2007. "Cultural Biases in Economic Exchange?," Economics Working Papers ECO2007/42, European University Institute. [Downloadable!]
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