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Gravity Models of the Intra-EU Trade: Application of the Hausman-Taylor Estimation in Heterogeneous Panels with Common Time-specific Factors

Abstract

In this paper we follow recent developments of panel data studies and explicitly allow for the existence of unobserved common time-specific factors where their individual responses are also allowed to be heterogeneous across cross section units. In the context of this extended panel data framework we generalize the Hausman-Taylor estimation methodology and develop the associated econometric theory. We apply our proposed estimation technique along with the conventional panel data approaches to a comprehensive analysis of the gravity equation of bilateral trade flows amongst the 15 European countries over 1960-2001. Empirical results clearly demonstrate that our proposed approach fits the data reasonably well and provides much more sensible results than the conventional approach based on the fixed time dummies. These findings may highlight the importance of allowing for a certain degree of cross section dependence through unobserved heterogeneous time specific common effects, otherwise the resulting estimates would be severely biased.

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Paper provided by Edinburgh School of Economics, University of Edinburgh in its series ESE Discussion Papers with number 105.

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Length: 32
Date of creation: Feb 2004
Handle: RePEc:edn:esedps:105
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Keywords: gravity models of trade; heterogeneous panel data; hausman-taylor estimation; time-specific common factors; intra-EU trade;

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Find related papers by JEL classification:
  • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
  • F14 - International Economics - - Trade - - - Empirical Studies of Trade

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