The bilateral trade balance of the EU in the presence of structural breaks

This paper examines the bilateral trade dynamics of the EU with its major trade partners. Previous studies on the bilateral trade dynamics of the EU have been based on estimations without the consideration of the presence of structural breaks. This paper examines the impacts of the real exchange rate and real income on the trade balance of the EU with its major trade partners in the presence of structural breaks. The empirical analysis includes ten major trade partners of the EU for 1980-2012, on a quarterly basis. The paper applies the Bai and Perron (1998) structural break test to determine the presence of structural breaks in series. In order to test the cointegration relationships of series, three different cointegration techniques were applied to the data. First, the Gregory and Hansen (1996) cointegration test was applied, which allows for one structural shift; then, for cases where two breaks were detected, the Hatemi-J (2008) cointegration test was employed. Finally, for countries where more than two breaks are detected, the Maki (2012) cointegration test was applied, which allows for an unknown number of breaks. The parameters of the model were estimated using the Bai and Perron (1998) procedure, which allows for structural breaks, and the OLS procedure without consideration of structural breaks. The paper investigates how the different dynamics of the bilateral trade balance of the EU appear after possible structural breaks consideration.