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Estimation of the Gravity Equation of Bilateral Trade in the Presence of Zero Flows

  • G.J.M. Linders

    ()

The gravity model is the workhorse model to describe and explain variation in bilateral trade empirically. Consistent with both Heckscher-Ohlin models and models of imperfect competition and trade, this versatile model has proven to be very successful, explaining a large part of the variance in trade flows. However, the loglinear model cannot straightforwardly account for the occurrence of zero-valued trade flows between pairs of countries. This paper investigates the various approaches suggested to deal with zero flows. Apart from the option to omit the zero flows from the sample, various extensions of Tobit estimation, truncated regression, probit regression and substitutions for zero flows have been suggested. We argue that the choice of method should be based on both economic and econometric considerations. The sample selection model appears to fit both considerations best. Moreover, we show that the choice of method may matter greatly for the results, especially if the fraction of zero flows in the sample is large. In the end, the results surprisingly suggest that the simplest solution, to omit zero flows from the sample, often leads to acceptable results, although the sample selection model is preferred theoretically and econometrically.

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Paper provided by European Regional Science Association in its series ERSA conference papers with number ersa06p746.

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Date of creation: Aug 2006
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Handle: RePEc:wiw:wiwrsa:ersa06p746
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  1. Andrew K. Rose, 2000. "One money, one market: the effect of common currencies on trade," Economic Policy, CEPR;CES;MSH, vol. 15(30), pages 7-46, 04.
  2. Heckman, James, 2013. "Sample selection bias as a specification error," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 31(3), pages 129-137.
  3. Andrew K. Rose, 2002. "Do We Really KNow that the WTO Increases Trade?," Working Papers 182002, Hong Kong Institute for Monetary Research.
  4. Barry Eichengreen & Douglas A. Irwin, 1998. "The Role of History in Bilateral Trade Flows," NBER Chapters, in: The Regionalization of the World Economy, pages 33-62 National Bureau of Economic Research, Inc.
  5. Cragg, John G, 1971. "Some Statistical Models for Limited Dependent Variables with Application to the Demand for Durable Goods," Econometrica, Econometric Society, vol. 39(5), pages 829-44, September.
  6. James E. Anderson & Douglas Marcouiller, 2002. "Insecurity And The Pattern Of Trade: An Empirical Investigation," The Review of Economics and Statistics, MIT Press, vol. 84(2), pages 342-352, May.
  7. James E. Rauch, 1996. "Networks versus Markets in International Trade," NBER Working Papers 5617, National Bureau of Economic Research, Inc.
  8. James E. Anderson & Eric van Wincoop, 2004. "Trade Costs," NBER Working Papers 10480, National Bureau of Economic Research, Inc.
  9. Soloaga, Isidro & Alan Wintersb, L., 2001. "Regionalism in the nineties: what effect on trade?," The North American Journal of Economics and Finance, Elsevier, vol. 12(1), pages 1-29, March.
  10. Bikker, Jacob A, 1987. "An International Trade Flow Model with Substitution: An Extension of the Gravity Model," Kyklos, Wiley Blackwell, vol. 40(3), pages 315-37.
  11. Jacob A. Bikker & Aart F. De Vos, 1992. "An international trade flow model with zero observations: an extension of the Tobit model," Brussels Economic Review, ULB -- Universite Libre de Bruxelles, vol. 135, pages 379-404.
  12. Wang, Z.K. & Winters, L.A., 1992. "The Trading Potential of Eastern Europe," Discussion Papers 92-21, Department of Economics, University of Birmingham.
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