Estimating the Gravity Model When Zero Trade Flows are Frequent and Economically Determined

This paper evaluates the performance of alternative estimators of the gravity equation when zero trade flows result from economically-based data-generating processes with heteroscedastic residuals and potentially-omitted variables. In a standard Mo...

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Bibliographic Details
Main Authors:	Martin, Will, Pham, Cong S.
Format:	Working Paper
Language:	English en_US
Published:	World Bank, Washington, DC 2015
Subjects:	PANEL DATA VARIABILITY REGRESSION MODEL MINIMIZATION ERRORS BINOMIAL DISTRIBUTION COEFFICIENTS LIMITED DEPENDENT VARIABLE NORMAL DISTRIBUTION DUMMY VARIABLES GDP PER CAPITA INFORMATION LINEAR FUNCTION EXPORTS ELASTICITY TRADE FLOWS LOGARITHMS DISTRIBUTION GRAVITY MODEL VARIABLES DEGREES OF FREEDOM ECONOMETRIC METHODS NONLINEARITY EXOGENOUS REGRESSORS NONLINEAR MODELS DUMMY VARIABLE NUMBER OF OBSERVATIONS PROBABILITIES PREFERENTIAL ACCESS INDEPENDENT VARIABLES CLASSIFICATIONS VARIABLE ESTIMATION KNOWLEDGE EMPIRICAL ANALYSIS BIASES MONTE CARLO SIMULATION GOODNESS OF FIT STANDARD DEVIATION DATA MAXIMUM LIKELIHOOD STEP ESTIMATOR LAY OUT EXOGENOUS VARIABLES TRADE BLOCS DECISION TREE PROBABILITY NOTATION LINEAR MODELS ECONOMETRICS CLUSTERING STANDARD ERRORS CASES CRITERIA LINEAR PROBABILITY MATRIX EXPLANATORY VARIABLES POSITIVE OBSERVATIONS ACCESS INDICATORS RESEARCH ARTICLE LIKELIHOOD FUNCTION ECONOMETRIC PROBLEMS LARGE NUMBER VOLUME OF TRADE RANDOM VARIABLES GRAVITY EQUATION ECONOMIC RESEARCH ERROR VARIANCE SELECTION MODEL LIMITED DEPENDENT VARIABLES MODEL RESULTS ECONOMIC SURVEYS INTERNATIONAL TRADE ECONOMETRIC ANALYSIS VALIDITY DESCRIPTION VALUE DEPENDENT VARIABLE POISSON DISTRIBUTION DISTRIBUTION FUNCTION LIKELIHOOD RATIO ERROR TERMS GAMMA DISTRIBUTION INDEX COEFFICIENT VECTOR EXPECTED VALUE DEPENDENT VARIABLES RESEARCHERS AGRICULTURE CORRELATION EQUATIONS STANDARD NORMAL DISTRIBUTION SAMPLES ERROR TERM MEASUREMENT ECONOMIC THEORY CONSTANT VARIANCE ASYMPTOTICALLY EQUIVALENT SURVEYS ECONOMICS ECONOMIC MODELS CASE LOG-LIKELIHOOD FUNCTION HETEROSCEDASTICITY INTEGER VALUES FIXED EFFECTS FUNCTIONAL FORMS JOURNAL OF ECONOMETRICS TRADE GDP THEORY BILATERAL TRADE STATISTICS EVALUATION STATA TRADE THEORIES PRECISION STANDARD ERROR WEBSITE SAMPLE SELECTION MAXIMUM LIKELIHOOD ESTIMATOR HOMOSCEDASTICITY LINEAR PROBABILITY MODEL RANDOM VARIABLE LINEAR REGRESSION ECONOMIC STATISTICS DEVELOPMENT POLICY
Online Access:	http://documents.worldbank.org/curated/en/2015/06/24641545/estimating-gravity-model-zero-trade-flows-frequent-economically-determined http://hdl.handle.net/10986/22182

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Summary:	This paper evaluates the performance of alternative estimators of the gravity equation when zero trade flows result from economically-based data-generating processes with heteroscedastic residuals and potentially-omitted variables. In a standard Monte Carlo analysis, the paper finds that this combination can create seriously biased estimates in gravity models with frequencies of zero frequently observed in real-world data, and that Poisson Pseudo-Maximum-Likelihood models can be important in solving this problem. Standard threshold–Tobit estimators perform well in a Tobit-based data-generating process only if the analysis deals with the heteroscedasticity problem. When the data are generated by a Heckman sample selection model, the Zero-Inflated Poisson model appears to have the lowest bias. When the data are generated by a Helpman, Melitz, and Rubinstein-type model with heterogeneous firms, a Zero-Inflated Poisson estimator including firm numbers appears to provide the best results. Testing on real-world data for total trade throws up additional puzzles with truncated Poisson Pseudo-Maximum-Likelihood and Poisson Pseudo-Maximum-Likelihood estimators being very similar, and Zero-Inflated Poisson and truncated Poisson Pseudo-Maximum-Likelihood identical. Repeating the Monte Carlo analysis taking into account the high frequency of very small predicted trade flows in real-world data reconciles these findings and leads to specific recommendations for estimators.

Estimating the Gravity Model When Zero Trade Flows are Frequent and Economically Determined

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