AbstractHeteroskedasticity and the existence of zero values in bilateral-trade data lead to significant biases in standard estimations of the gravity equation. We propose a new estimation technique that addresses these problems, and provide novel estimates of the gravity equation. Three results stand out. First, contrary to general belief, income elasticities are significantly smaller than 1, suggesting modifications to standard trade models. Second, simple estimators of the gravity equation greatly exaggerate the roles of distance and colonial links. Finally, bilateral trade between countries that have signed a free-trade agreement is 30 percent larger than that between other countries, a magnitude remarkably different from that predicted by conventional methods (above 100 percent).
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Bibliographic InfoPaper provided by Federal Reserve Bank of Boston in its series Working Papers with number 03-1.
Date of creation: 2003
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-03-03 (All new papers)
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