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Information Frictions and the Law of One Price: “When the States and the Kingdom became United”

  • Steinwender, Claudia
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    How do information frictions distort international trade? This paper exploits a unique historical experiment to estimate the magnitude of these distortions: the establishment of the transatlantic telegraph connection in 1866. I use a newly collected data set based on historical newspaper records that provides daily data on information flows across the Atlantic together with detailed, daily information on prices and trade flows of cotton. Information frictions result in large and volatile deviations from the Law of One Price. What is more, the elimination of information frictions has real effects: Exports respond to information about foreign demand shocks. Average trade flows increase after the telegraph and become more volatile, providing a more efficient response to demand shocks. I build a model of international trade that can explain the empirical evidence. In the model, exporters use the latest news about a foreign market to forecast expected selling prices when their exports arrive at the destination. Their forecast error is smaller and less volatile the more recent the available information. I estimate the welfare gains from information transmission through the telegraph to be roughly equivalent to those from abolishing a 6% ad valorem tariff.

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    File URL: http://www.cepremap.fr/depot/docweb/docweb1314.pdf
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    Paper provided by CEPREMAP in its series CEPREMAP Working Papers (Docweb) with number 1314.

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    Length: 51 pages
    Date of creation: Dec 2013
    Date of revision:
    Handle: RePEc:cpm:docweb:1314
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    1. Jeffrey R. Brown & Austan Goolsbee, 2002. "Does the Internet Make Markets More Competitive? Evidence from the Life Insurance Industry," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 481-507, June.
    2. Andrew Coleman, 2009. "Storage, Slow Transport, and the Law of One Price: Theory with Evidence from Nineteenth-Century U.S. Corn Markets," The Review of Economics and Statistics, MIT Press, vol. 91(2), pages 332-350, May.
    3. Albornoz-Crespo, Facundo & Calvo Pardo, Hector F. & Corcos, Gregory & Ornelas, Emanuel, 2010. "Sequential Exporting," CEPR Discussion Papers 8103, C.E.P.R. Discussion Papers.
    4. David Hummels & Georg Schaur, 2012. "Time as a Trade Barrier," NBER Working Papers 17758, National Bureau of Economic Research, Inc.
    5. Aparajita Goyal, 2010. "Information, Direct Access to Farmers, and Rural Market Performance in Central India," American Economic Journal: Applied Economics, American Economic Association, vol. 2(3), pages 22-45, July.
    6. Hummels, David L. & Schaur, Georg, 2010. "Hedging price volatility using fast transport," Journal of International Economics, Elsevier, vol. 82(1), pages 15-25, September.
    7. James Harrigan & Carolyn Evans, 2004. "Distance, Time and Specialization," Econometric Society 2004 North American Winter Meetings 640, Econometric Society.
    8. Garbade, Kenneth D & Silber, William L, 1978. "Technology, Communication and the Performance of Financial Markets: 1840-1975," Journal of Finance, American Finance Association, vol. 33(3), pages 819-32, June.
    9. James Harrigan, 2005. "Airplanes and Comparative Advantage," NBER Working Papers 11688, National Bureau of Economic Research, Inc.
    10. Treb Allen, 2012. "Information Frictions in Trade," 2012 Meeting Papers 125, Society for Economic Dynamics.
    11. repec:cup:cbooks:9780521326162 is not listed on IDEAS
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