A Spatial Diffusion Model with Common Factors and an Application to Cigarette Consumption
29 Pages Posted: 31 May 2016
Date Written: May 12, 2016
This paper adopts a dynamic spatial panel data model with common factors to explain the non-stationary diffusion process of cigarette consumption across 69 Italian provinces over the period 1877-1913. The Pesaran (2015) CD-test and the exponent-test of Bailey et al. (2015) are used to show that both weak and strong cross-sectional dependence are important drivers of the propagation of cigarette demand over this period. Stabilitytests on the coefficients and the CD-test on the residuals of the model are used to verify whether the data and both forms of cross-sectional dependence are modeled adequately. Cigarettes are found to be a normal good with an income elasticity of 0.4 and a price elasticity -0.4 in the long term. The price elasticity can be decomposed into a direct effect of -0.54 in the own region and a spillover effect to other regions of 0.15. This positive spillover effect is in line with previous spatial econometric studies which investigated cigarette demand in the U.S. states over a more recent period.
Keywords: diffusion, non-stationarity, spatial dependence, common factors, cigarette demand
JEL Classification: C21, C23, N33, N93, R22
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