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Estimating the Gravity Model When Zero Trade Flows are Frequent

In this paper we estimate the gravity model allowing for the pervasive issues of heteroscedasticity and zero bilateral trade flows identified in an influential recent 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 appears 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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File URL: http://www.deakin.edu.au/buslaw/aef/workingpapers/papers/2008_03eco.pdf
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Paper provided by Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance in its series Economics Series with number 2008_03.

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Length: 47 pages
Date of creation: 12 Oct 2008
Date of revision:
Handle: RePEc:dkn:econwp:eco_2008_03
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Web page: http://www.deakin.edu.au/buslaw/aef/index.php

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  1. Hallak, Juan Carlos, 2006. "Product quality and the direction of trade," Journal of International Economics, Elsevier, vol. 68(1), pages 238-265, January.
  2. Elhanan Helpman & Marc Melitz & Yona Rubinstein, 2008. "Estimating Trade Flows: Trading Partners and Trading Volumes," The Quarterly Journal of Economics, MIT Press, vol. 123(2), pages 441-487, 05.
  3. Nawata, Kazumitsu, 1994. "Estimation of sample selection bias models by the maximum likelihood estimator and Heckman's two-step estimator," Economics Letters, Elsevier, vol. 45(1), pages 33-40, May.
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  6. James E. Anderson & Eric van Wincoop, 2001. "Gravity with Gravitas: A Solution to the Border Puzzle," NBER Working Papers 8079, National Bureau of Economic Research, Inc.
  7. Joao Santos Silva & Silvana Tenreyro, 2005. "The Log of Gravity," CEP Discussion Papers dp0701, Centre for Economic Performance, LSE.
  8. Xuepeng Liu, 2009. "GATT/WTO Promotes Trade Strongly: Sample Selection and Model Specification," Review of International Economics, Wiley Blackwell, vol. 17(3), pages 428-446, 08.
  9. Richard Baldwin & James Harrigan, 2011. "Zeros, Quality, and Space: Trade Theory and Trade Evidence," American Economic Journal: Microeconomics, American Economic Association, vol. 3(2), pages 60-88, May.
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  13. Terza, Joseph V., 1985. "A Tobit-type estimator for the censored Poisson regression model," Economics Letters, Elsevier, vol. 18(4), pages 361-365.
  14. Greene, William H, 1981. "On the Asymptotic Bias of the Ordinary Least Squares Estimator of the Tobit Model," Econometrica, Econometric Society, vol. 49(2), pages 505-13, March.
  15. Puhani, Patrick A, 2000. " The Heckman Correction for Sample Selection and Its Critique," Journal of Economic Surveys, Wiley Blackwell, vol. 14(1), pages 53-68, February.
  16. Powell, James L., 1984. "Least absolute deviations estimation for the censored regression model," Journal of Econometrics, Elsevier, vol. 25(3), pages 303-325, July.
  17. Hurd, Michael, 1979. "Estimation in truncated samples when there is heteroscedasticity," Journal of Econometrics, Elsevier, vol. 11(2-3), pages 247-258.
  18. Duan, Naihua, et al, 1983. "A Comparison of Alternative Models for the Demand for Medical Care," Journal of Business & Economic Statistics, American Statistical Association, vol. 1(2), pages 115-26, April.
  19. Kenneth Y. Chay & James L. Powell, 2001. "Semiparametric Censored Regression Models," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 29-42, Fall.
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