Gravity, Counterparties, and Foreign Investment
64 Pages Posted: 15 Mar 2018 Last revised: 18 Sep 2018
Date Written: September 18, 2018
Gravity models excel at explaining international trade and investment flows; their success poses a continuing puzzle. In a comprehensive dataset of cross-border transactions in high-value commercial real estate, we find that the role of distance in the gravity model is well explained by preferential matching between counterparties (buyers and sellers) of the same nationality. This tendency is large and robust, holds true for a majority of nationalities regardless of investment location, and increases in poor and poorly-governed locations. We build and structurally estimate an equilibrium search model embedding a matching friction affecting different-nationality counterparty transactions. Both liquidity and prices in the market rise substantially in the counterfactual frictionless economy. The model helps explain the persistent success of gravity using a combination of frictions generating preferential matching with counterparties of the same nationality, and the observed location choices of counterparties in the data.
Keywords: Nationality Bias, Search and Matching, Commercial Real Estate
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