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Estimating Gravity Equations: To Log or Not to Log?

  • Boriss Siliverstovs
  • Dieter Schumacher

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.

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File URL: http://www.diw.de/documents/publikationen/73/diw_01.c.74342.de/dp739.pdf
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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 739.

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Length: 38 p.
Date of creation: 2007
Date of revision:
Handle: RePEc:diw:diwwpp:dp739
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  1. 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.
  2. James E. Anderson & Eric van Wincoop, 2000. "Gravity with Gravitas: A Solution to the Border Puzzle," Boston College Working Papers in Economics 485, Boston College Department of Economics.
  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. Anderson, James E, 1979. "A Theoretical Foundation for the Gravity Equation," American Economic Review, American Economic Association, vol. 69(1), pages 106-16, March.
  5. James E. Anderson & Eric van Wincoop, 2004. "Trade Costs," NBER Working Papers 10480, National Bureau of Economic Research, Inc.
  6. Dieter Schumacher & Boriss Siliverstovs, 2006. "Home-Market and Factor-Endowment Effects in a Gravity Approach," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 142(2), pages 330-353, July.
  7. Joao Santos Silva & Silvana Tenreyro, 2005. "The log of gravity," LSE Research Online Documents on Economics 3744, London School of Economics and Political Science, LSE Library.
  8. 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.
  9. 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 474-81, August.
  10. André Sapir, 1981. "Trade benefits under the EEC generalized system of preferences," ULB Institutional Repository 2013/8290, ULB -- Universite Libre de Bruxelles.
  11. 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 881-92, December.
  12. 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 143-53, February.
  13. Deardorff, Alan V, 1982. "The General Validity of the Heckscher-Ohlin Theorem," American Economic Review, American Economic Association, vol. 72(4), pages 683-94, September.
  14. 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.
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