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Estimating the Gravity Equation when Zero Trade Flows are Frequent

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Martin, Will
Pham, Cong S.

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Abstract

In this paper we estimate the gravity model allowing for the pervasive issues of heteroscedasticity and zero bilateral trade flows identified in an influential paper by Santos Silva and Tenreyro. We use Monte Carlo simulations with data generated using a heteroscedastic, limited-dependent-variable process to investigate the extent to which different estimators can deal with the resulting parameter biases. While the Poisson Pseudo-Maximum Likelihood estimator recommended by Santos Silva and Tenreyro solves the heteroscedasticity-bias problem when this is the only problem, it apprears to yield severely biased estimates when zero trade values are frequent. Standard threshold-Tobit estimators perform better as long as the heteroscedasticity problem is satisfactorily dealt with. The Heckman Maximum Likelihood estimators appear to perform well if true identifying restrictions are available.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 9453.

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Date of creation: 2008
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Handle: RePEc:pra:mprapa:9453

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Related research
Keywords: International trade Gravity equation Limited dependent variable regression Poisson pseudo-maximum likelihood Zero trade flows

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Find related papers by JEL classification:
C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Estimation
P45 - Economic Systems - - Other Economic Systems - - - International Linkages
C01 - Mathematical and Quantitative Methods - - General - - - Econometrics

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