Gravity, Counterparties, and Foreign Investment
77 Pages Posted: 15 Mar 2018 Last revised: 31 Jan 2019
Date Written: January 24, 2019
Gravity models excel at explaining international trade and investment flows; their success poses a continuing puzzle. In a comprehensive dataset of global commercial real-estate investments, we find that the role of distance in the gravity model is well-explained by preferential matching between counterparties of the same nationality. This tendency for same-country matching is widespread, robust, and increases in poorly-governed locations. We structurally estimate an equilibrium matching model with a friction affecting different-nationality transactions. The model explains the persistent success of gravity using a combination of this friction and the spatial distribution of same-nationality counterparties, which is well-predicted by current and historical linguistic, cultural, and trade links between countries.
Keywords: Gravity, Foreign investment, Commercial real estate, Trust, Matching, Cross-border flows
JEL Classification: D83, F14, F30, G11
Suggested Citation: Suggested Citation