Robust Determinants of Bilateral Trade

What are the policies and country-level conditions which best explain bilateral trade flows between countries? The beloved “gravity model” has had widespread empirical success, yet there is little guidance on which set of explanatory variables appropriately balances in-sample fit against out-of-sample prediction. Toward that end, this paper examines the problem of model selection, using modern empirical methods, in two steps. First, we use data from 1970 to 2000 as a baseline period to estimate the gravity model according three model selection methods – Lasso regularized regression, Bayesian Model Averaging, and Extreme Bound Analysis. We consider a wide variety of candidate variables commonly found in empirical gravity models. We find that about ¼ of commonly used variables found in empirical gravity equations are not robust. We explore the sensitivity of the prediction results to the specific regularization method and the choice of tuning parameters. We find surprising consistency in the set of variables selected by the various measured considered.