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International Trade Efficiency, the Gravity Equation, and the Stochastic Frontier

Author

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  • Heejoon Kang

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

  • Michele Fratianni

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

Abstract

In the gravity equation of international trade, bilateral trade flows are regressed on trading partners’ income and the distance that separates them along with other variables. This widely used equation is traditionally estimated by the ordinary least squares method. We employ an alternative technique of stochastic frontier estimation to assess the potential bilateral trade flows from the same gravity equation. Countries are shown to have low efficiencies in their international trade as the predicted trade from frontier estimation is generally far greater than actual trade. Trade efficiencies are computed and ranked for individual countries, ten geographical regions, and eleven regional trade agreements.

Suggested Citation

  • Heejoon Kang & Michele Fratianni, 2006. "International Trade Efficiency, the Gravity Equation, and the Stochastic Frontier," Working Papers 2006-08, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  • Handle: RePEc:iuk:wpaper:2006-08
    as

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    File URL: http://kelley.iu.edu/riharbau/RePEc/iuk/wpaper/bepp2006-08-kang-fratianni.pdf
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    References listed on IDEAS

    as
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    3. Fare,Rolf & Grosskopf,Shawna & Lovell,C. A. Knox, 2008. "Production Frontiers," Cambridge Books, Cambridge University Press, number 9780521072069, March.
    4. Andrew K. Rose, 1999. "One Money, One Market: Estimating the Effect of Common Currencies on Trade," NBER Working Papers 7432, National Bureau of Economic Research, Inc.
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    6. Hunt-McCool, Janet & Koh, Samuel C & Francis, Bill B, 1996. "Testing for Deliberate Underpricing in the IPO Premarket: A Stochastic Frontier Approach," Review of Financial Studies, Society for Financial Studies, vol. 9(4), pages 1251-1269.
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    Citations

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    Cited by:

    1. Deluna, Roperto Jr, 2013. "Trade Performance and Potential of the Philippines: An Application of Stochastic Frontier Gravity Model," MPRA Paper 51677, University Library of Munich, Germany.
    2. Balogun, Emmanuel Dele, 2007. "Exchange rate policy and export performance of WAMZ countries," MPRA Paper 6233, University Library of Munich, Germany.
    3. Yu SHENG & Yanrui WU & Xunpeng SHI & Dandan ZHANG, 2014. "Markket Integration and Energy Trade Efficiency: An Application of Malmqvist Index to Analyse Multi-Product Trade," Working Papers DP-2014-20, Economic Research Institute for ASEAN and East Asia (ERIA).
    4. Deluna, Roperto Jr & Cruz, Edgardo, 2014. "Philippine Export Efficiency and Potential: An Application of Stochastic Frontier Gravity Model," MPRA Paper 53580, University Library of Munich, Germany.
    5. Sheng, Yu & Wu, Yanrui & Shi, Xunpeng & Zhang, Dandan, 2015. "Energy trade efficiency and its determinants: A Malmquist index approach," Energy Economics, Elsevier, vol. 50(C), pages 306-314.
    6. repec:ejn:ejefjr:v:5:y:2017:i:4:p:1-15 is not listed on IDEAS
    7. repec:era:chaptr:2013-rpr-29-06 is not listed on IDEAS
    8. Rodolfo Metulini, 2013. "A structural analysis on Gravity of Trade regarding the possibility to remove distance from the model," ERSA conference papers ersa13p520, European Regional Science Association.

    More about this item

    Keywords

    efficiency coefficients; OLS residuals; trade gravity; trade potentials;

    JEL classification:

    • F10 - International Economics - - Trade - - - General
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General

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