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A Solution to the Missing Globalization Puzzle by Non-CES Preferences

Hakan Yilmazkuday

Florida International University

November 12, 2013

One channel of globalization is through the increasing integration of trade. Although this is attributed to decreasing effects of distance across countries (due to advances in transportation technology and/or the expansion of trade agreements to distant countries), the working-horse models of gravity fail to capture it because of resulting in non-decreasing distance elasticity of trade estimates over time, the so-called the missing globalization or the distance puzzle. This paper shows that this puzzle arises due to the restricting assumption of constant elasticity of substitution (CES) preferences working behind the gravity models. We test the validity of this assumption for different trade intervals and show that the implied distance elasticity of distance (under CES preferences) decrease with trade; therefore the assumption of CES is violated. Accordingly, we consider a type of non-CES utility function, namely constant absolute risk version (CARA), and analytically show that the negative relation between trade and distance elasticity of trade is captured by CARA preferences. We also estimate the gravity equation implied by CARA preferences and empirically confirm the endogenous relation between trade and distance elasticity of trade. According to the data set used, CARA preferences are also econometrically selected over CES preferences based on their goodness of fit.

Number of Pages in PDF File: 31

Keywords: Distance Puzzle, Non-CES Preferences, U.S. Imports

JEL Classification: F12, F13, F14

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Date posted: May 2, 2013 ; Last revised: November 13, 2013

Suggested Citation

Yilmazkuday, Hakan, A Solution to the Missing Globalization Puzzle by Non-CES Preferences (November 12, 2013). Available at SSRN: https://ssrn.com/abstract=2258804 or http://dx.doi.org/10.2139/ssrn.2258804

Contact Information

Hakan Yilmazkuday (Contact Author)
Florida International University ( email )
11200 SW 8th Street
Miami, FL 33199
United States
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