Structural Estimation of a Gravity Model of Trade with the Constant-Difference-of-Elasticities

This paper presents a general equilibrium gravity model of trade based on the constant difference of elasticities of substitution preferences. Hanoch (1975) illustrates these preferences' advantages in terms of parsimony and flexibility. This paper introduces a parsimonious, non-homothetic and globally well-behaved demand model into the gravity model that both separates substitution effects from income effects and has non-constant substitution elasticities. These features of the demand model---together with the structural estimation procedure devised in this paper---allow nesting several prominent theoretical motivations for the gravity model, and exploring the merits of this more general model. They also allow identification of the elasticity of trade costs with respect to distance and asymmetric border coefficients from the elasticity of trade flows with respect to trade costs, that are not easily identified in most previous studies. This paper develops a new method of computing counterfactual equilibrium which works best for large and complex general equilibrium models, and particularly those models that use implicit demand models.