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Estimating Gravity Equations: To Log or Not to Log?

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  • Boriss Siliverstovs
  • Dieter Schumacher

Abstract

This study compares two alternative approaches to estimate parameters in gravity equations. We compare the traditional OLS approach applied to the log-linear form of the gravity model with the Poisson Quasi Maximum Likelihood (PQML) estimation procedure applied to the non-linear multiplicative specification of the gravity model. We use the trade flows for all products, for all manufacturing products as well as for manufacturing products broken down by three-digit ISIC Rev.2 categories. We base our conclusions on the generalised gravity model of Bergstrand (1989) that allows us to investigate differences in factor-proportions and home-market effects at the industry level. In addition, we compare the effects of other explanatory variables such as exporter and importer total income, distance, preferential trade agreements, common border, historical ties, and common language on the volume of trade. Our study provides comprehensive evidence on likely qualitative and/or quantitative differences in the values of estimated coefficients as a result of application of an alternative estimation method. Our main conclusion is that both estimation results as well as results of the regression misspecification tests provide supporting evidence for the PQML estimation approach over the OLS estimation method.

Suggested Citation

  • Boriss Siliverstovs & Dieter Schumacher, 2007. "Estimating Gravity Equations: To Log or Not to Log?," Discussion Papers of DIW Berlin 739, DIW Berlin, German Institute for Economic Research.
  • Handle: RePEc:diw:diwwpp:dp739
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    References listed on IDEAS

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    1. James E. Anderson & Eric van Wincoop, 2004. "Trade Costs," Journal of Economic Literature, American Economic Association, vol. 42(3), pages 691-751, September.
    2. James E. Anderson & Eric van Wincoop, 2003. "Gravity with Gravitas: A Solution to the Border Puzzle," American Economic Review, American Economic Association, vol. 93(1), pages 170-192, March.
    3. Robert C. Feenstra & James R. Markusen & Andrew K. Rose, 2001. "Using the gravity equation to differentiate among alternative theories of trade," Canadian Journal of Economics, Canadian Economics Association, vol. 34(2), pages 430-447, May.
    4. Bergstrand, Jeffrey H, 1985. "The Gravity Equation in International Trade: Some Microeconomic Foundations and Empirical Evidence," The Review of Economics and Statistics, MIT Press, vol. 67(3), pages 474-481, August.
    5. Geraci, Vincent J & Prewo, Wilfried, 1977. "Bilateral Trade Flows and Transport Costs," The Review of Economics and Statistics, MIT Press, vol. 59(1), pages 67-74, February.
    6. Aitken, Norman D, 1973. "The Effect of the EEC and EFTA on European Trade: A Temporal Cross-Section Analysis," American Economic Review, American Economic Association, vol. 63(5), pages 881-892, December.
    7. J. M. C. Santos Silva & Silvana Tenreyro, 2006. "The Log of Gravity," The Review of Economics and Statistics, MIT Press, vol. 88(4), pages 641-658, November.
    8. André Sapir, 1981. "Trade benefits under the EEC generalized system of preferences," ULB Institutional Repository 2013/8290, ULB -- Universite Libre de Bruxelles.
    9. Simon Peters, 2000. "On the use of the RESET test in microeconometric models," Applied Economics Letters, Taylor & Francis Journals, vol. 7(6), pages 361-365.
    10. Dieter Schumacher & Boriss Siliverstovs, 2006. "Home-Market and Factor-Endowment Effects in a Gravity Approach," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 142(2), pages 330-353, July.
    11. Bergstrand, Jeffrey H, 1989. "The Generalized Gravity Equation, Monopolistic Competition, and the Factor-Proportions Theory in International Trade," The Review of Economics and Statistics, MIT Press, vol. 71(1), pages 143-153, February.
    12. Deardorff, Alan V, 1982. "The General Validity of the Heckscher-Ohlin Theorem," American Economic Review, American Economic Association, vol. 72(4), pages 683-694, September.
    13. Manning, Willard G. & Mullahy, John, 2001. "Estimating log models: to transform or not to transform?," Journal of Health Economics, Elsevier, vol. 20(4), pages 461-494, July.
    14. Anderson, James E, 1979. "A Theoretical Foundation for the Gravity Equation," American Economic Review, American Economic Association, vol. 69(1), pages 106-116, March.
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    More about this item

    Keywords

    generalised gravity equation; Poisson regression;

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation

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