Estimating Gravity Models of International Trade with Correlated Time-Fixed Regressors: To IV or not IV?
Gravity type models are widely used in international economics. In these models the inclusion of time-fi0xed regressors like geographical or cultural distance, language and institutional (dummy) variables is often of vital importance e.g. to analyse the impact of trade costs on internationalization activity. This paper assesses the problem of parameter inconsistency due to a correlation of the time-fixed regressors with the combined error term in panel data settings. A common solution is to use Instrumental-Variable (IV) estimation in the spirit of Hausman-Taylor (1981) since a standard Fixed Effect Model (FEM) estimation is not applicable. However, some potential shortcomings of the latter approach recently gave rise to the use of non-IV two-step estimators. Given their growing number of empirical applications, we aim to compare the performance of IV and non-IV approaches in the presence of time-fixed variables and right hand side endogeneity using Monte Carlo simulations, where we explicitly control for the problem of IV selection in the Hausman-Taylor case. The simulation results show that the Hausman-Taylor model with perfect-knowledge about the underlying data structure (instrument orthogonality) has on average the smallest bias. However, compared to the empirically relevant specification with imperfect-knowledge and instruments chosen by statistical criteria, simple non-IV rival estimators performs equally well or even better. We illustrate these findings by estimating gravity type models for German regional export activity within the EU. The results show that the HT specification is likely to overestimate the role of trade costs proxied by geographical distance.
|Date of creation:||22 Aug 2010|
|Date of revision:|
|Contact details of provider:|| Postal: Avenue de Beaulieu, 1160 Brussels|
Phone: +322 299 3523
Fax: +322 299 3523
Web page: http://www.eeri.eu/index.htm
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Signe Krogstrup & Sébastien Wälti, 2007.
"Do fiscal rules cause budgetary outcomes?,"
Trinity Economics Papers
tep0607, Trinity College Dublin, Department of Economics.
- Buch, Claudia M. & Piazolo, Daniel, 2001.
"Capital and trade flows in Europe and the impact of enlargement,"
Elsevier, vol. 25(3), pages 183-214, September.
- Claudia M. Buch & Daniel Piazolo, 2000. "Capital and Trade Flows in Europe and the Impact of Enlargement," Kiel Working Papers 1001, Kiel Institute for the World Economy.
- Piazolo, Daniel & Buch, Claudia M., 2000. "Capital and Trade Flows in Europe and the Impact of Enlargement," Kiel Working Papers 1001, Kiel Institute for the World Economy (IfW).
- Hausman, Jerry, 2015.
"Specification tests in econometrics,"
Publishing House "SINERGIA PRESS", vol. 38(2), pages 112-134.
- Arnold, Jens Matthias & Hussinger, Katrin, 2005.
"Exports versus FDI in German Manufacturing: Firm Performance and Participation in International Markets,"
ZEW Discussion Papers
05-73, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
- Jens M. Arnold & Katrin Hussinger, 2010. "Exports versus FDI in German Manufacturing: Firm Performance and Participation in International Markets," Review of International Economics, Wiley Blackwell, vol. 18(4), pages 595-606, 09.
- Arnold, Jens Matthias & Hussinger, Katrin, 2006. "Exports versus FDI in German manufacturing: firm performance and participation in international markets," Discussion Paper Series 1: Economic Studies 2006,04, Deutsche Bundesbank, Research Centre.
- Fritz Breuss & Peter Egger, 1999. "How Reliable Are Estimations of East-West Trade Potentials Based on Cross-Section Gravity Analyses?," Empirica, Springer, vol. 26(2), pages 81-94, June.
- Guglielmo Caporale & Christophe Rault & Robert Sova & Anamaria Sova, 2009.
"On the bilateral trade effects of free trade agreements between the EU-15 and the CEEC-4 countries,"
Review of World Economics (Weltwirtschaftliches Archiv),
Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 145(2), pages 189-206, July.
- Guglielmo Caporale & Christophe Rault & Robert Sova & Anamaria Sova, 2009. "On the bilateral trade effects of free trade agreements between the EU-15 and the CEEC-4 countries," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 145(3), pages 573-573, October.
- Guglielmo Maria Caporale & Christophe Rault & Ana Maria Sova & Robert Sova, 2008. "On the Bilateral Trade Effects of Free Trade Agreements between the EU-15 and the CEEC-4 Countries," Post-Print halshs-00363693, HAL.
- Caporale, Guglielmo Maria & Rault, Christophe & Sova, Anamaria & Sova, Robert, 2008. "On the Bilateral Trade Effects of Free Trade Agreements between the EU-15 and the CEEC-4 Countries," IZA Discussion Papers 3782, Institute for the Study of Labor (IZA).
- Guglielmo Maria Caporale & Christophe Rault & Robert Sova & Ana Maria Sova, 2008. "On the Bilateral Trade Effects of Free Trade Agreements between the EU-15 and the CEEC-4 Countries," CESifo Working Paper Series 2419, CESifo Group Munich.
- Baltagi, Badi H. & Bresson, Georges & Pirotte, Alain, 2003. "Fixed effects, random effects or Hausman-Taylor?: A pretest estimator," Economics Letters, Elsevier, vol. 79(3), pages 361-369, June.
- Jarko Fidrmuc, 2009. "Gravity models in integrated panels," Empirical Economics, Springer, vol. 37(2), pages 435-446, October.
- Anne-Célia Disdier & Keith Head, 2004.
"The Puzzling Persistence of the Distance Effect on Bilateral Trade,"
Development Working Papers
186, Centro Studi Luca d'Agliano, University of Milano.
- Anne-Célia Disdier & Keith Head, 2008. "The Puzzling Persistence of the Distance Effect on Bilateral Trade," The Review of Economics and Statistics, MIT Press, vol. 90(1), pages 37-48, February.
- Anne-Célia Disdier & Keith Head, 2008. "The puzzling persistence of the distance effect on bilateral trade," Post-Print hal-01172854, HAL.
- Daniel J. Henderson & Daniel L. Millimet, 2008.
"Is gravity linear?,"
Journal of Applied Econometrics,
John Wiley & Sons, Ltd., vol. 23(2), pages 137-172.
- Zwinkels, Remco C.J. & Beugelsdijk, Sjoerd, 2010. "Gravity equations: Workhorse or Trojan horse in explaining trade and FDI patterns across time and space?," International Business Review, Elsevier, vol. 19(1), pages 102-115, February.
- Hong, Han & Preston, Bruce & Shum, Matthew, 2003. "Generalized Empirical Likelihood Based Model Selection Criteria For Moment Condition Models," Econometric Theory, Cambridge University Press, vol. 19(06), pages 923-943, December.
- Ansgar Belke & Julia Spies, 2008.
"Enlarging the EMU to the east: what effects on trade?,"
Springer, vol. 35(4), pages 369-389, September.
- Belke, Ansgar & Spies, Julia, 2007. "Enlarging the EMU to the east: What effects on trade?," Ruhr Economic Papers 21, Rheinisch-Westfälisches Institut für Wirtschaftsforschung (RWI), Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
- Belke, Ansgar H. & Spies, Julia, 2008. "Enlarging the EMU to the East: What Effects on Trade?," IZA Discussion Papers 3647, Institute for the Study of Labor (IZA).
- Christopher F Baum & Mark E Schaffer & Steven Stillman, 2002. "IVREG2: Stata module for extended instrumental variables/2SLS and GMM estimation," Statistical Software Components S425401, Boston College Department of Economics, revised 09 Feb 2016.
- Baltagi, Badi H. & Chang, Young-Jae, 2000. "Simultaneous Equations With Incomplete Panels," Econometric Theory, Cambridge University Press, vol. 16(02), pages 269-279, April.
- Baldwin, Richard & Taglioni, Daria, 2006.
"Gravity for Dummies and Dummies for Gravity Equations,"
CEPR Discussion Papers
5850, C.E.P.R. Discussion Papers.
- Richard Baldwin & Daria Taglioni, 2006. "Gravity for Dummies and Dummies for Gravity Equations," NBER Working Papers 12516, National Bureau of Economic Research, Inc.
- Mitze, Timo & Alecke, Björn & Untiedt, Gerhard, 2009. "Trade-FDI Linkages in a System of Gravity Equations for German Regional Data," Ruhr Economic Papers 84, Rheinisch-Westfälisches Institut für Wirtschaftsforschung (RWI), Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
- Elhanan Helpman & Marc J. Melitz & Stephen R. Yeaple, 2003.
"Export versus FDI,"
Harvard Institute of Economic Research Working Papers
1998, Harvard - Institute of Economic Research.
- Hausman, Jerry A. & Taylor, William E., 1981.
"Panel data and unobservable individual effects,"
Journal of Econometrics,
Elsevier, vol. 16(1), pages 155-155, May.
- Egger, Peter, 2000.
"A note on the proper econometric specification of the gravity equation,"
Elsevier, vol. 66(1), pages 25-31, January.
- Peter Egger, . "A Note on the Proper Econometric Specification of the Gravity Equation," WIFO Working Papers 108, WIFO.
- Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-47, February.
- Dieter Schumacher & Parvati Trübswetter, 2000. "Volume and Comparative Advantage in East-West Trade," Discussion Papers of DIW Berlin 223, DIW Berlin, German Institute for Economic Research.
- Miren Lafourcade & Elisenda Paluzie Hernandez, 2005. "European Integration, FDI and the Internal Geography of Trade: Evidence from Western European Border Regions," Working Papers in Economics 145, Universitat de Barcelona. Espai de Recerca en Economia.
- J. Caetano & A. Galego & E. Vaz & C. Vieira & I. Vieira, 2002. "The Eastward Enlargement of the Eurozone: Trade and FDI," Eastward Enlargement of the Euro-zone Working Papers wp07, Free University Berlin, Jean Monnet Centre of Excellence, revised 01 Aug 2002.
- Mundlak, Yair, 1978. "On the Pooling of Time Series and Cross Section Data," Econometrica, Econometric Society, vol. 46(1), pages 69-85, January.
- Björn Alecke, 2003. "Das Handelsvolumen der ostdeutschen Bundesländer mit Polen und Tschechien im Zuge der EU-Erweiterung: Ergebnisse auf Basis eines Gravitationsmodells," Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Economic Research, DIW Berlin, German Institute for Economic Research, vol. 72(4), pages 565-578.
- Manuel Arellano & Stephen Bond, 1991.
"Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations,"
Review of Economic Studies,
Oxford University Press, vol. 58(2), pages 277-297.
- Tom Doan, . "RATS program to replicate Arellano-Bond 1991 dynamic panel," Statistical Software Components RTZ00169, Boston College Department of Economics.
- Gert-Jan M. Linders, 2005. "Distance Decay in International Trade Patterns - a Meta-analysis," ERSA conference papers ersa05p679, European Regional Science Association.
- So Im, Kyung & Ahn, Seung C. & Schmidt, Peter & Wooldridge, Jeffrey M., 1999. "Efficient estimation of panel data models with strictly exogenous explanatory variables," Journal of Econometrics, Elsevier, vol. 93(1), pages 177-201, November.
- Jakab, Zoltan M. & Kovacs, Mihaly A. & Oszlay, Andras, 2001. "How Far Has Trade Integration Advanced?: An Analysis of the Actual and Potential Trade of Three Central and Eastern European Countries," Journal of Comparative Economics, Elsevier, vol. 29(2), pages 276-292, June.
- Andrews, Donald W. K. & Lu, Biao, 2001. "Consistent model and moment selection procedures for GMM estimation with application to dynamic panel data models," Journal of Econometrics, Elsevier, vol. 101(1), pages 123-164, March.
- Laszlo Matyas, 1997. "Proper Econometric Specification of the Gravity Model," The World Economy, Wiley Blackwell, vol. 20(3), pages 363-368, 05.
When requesting a correction, please mention this item's handle: RePEc:eei:rpaper:eeri_rp_2010_22. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Julia van Hove)
If references are entirely missing, you can add them using this form.