Gravity with Granularity

42 Pages Posted: 3 Nov 2020

See all articles by Holger Breinlich

Holger Breinlich

University of Surrey - School of Economics; Centre for Economic Policy Research (CEPR); London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Harald Fadinger

University of Mannheim

Volker Nocke

University of Mannheim

Nicolas Schutz

University of Mannheim

Date Written: October 2020

Abstract

We evaluate the consequences of oligopolistic behavior for the estimation of gravity equations for trade flows. With oligopolistic competition, firm-level gravity equations based on a standard CES demand framework need to be augmented by markup terms that are functions of firms' market shares. At the aggregate level, the additional term takes the form of the exporting country's market share in the destination country multiplied by an exporter-destination-specific Herfindahl-Hirschman index. For both cases, we show how to construct appropriate correction terms that can be used to avoid problems of omitted variable bias. We illustrate the quantitative importance of our results for combined French and Chinese firm-level export data as well as for a sample of product-level imports by European countries. Our results show that correcting for oligopoly bias can lead to substantial changes in the coefficients on standard gravity regressors such as distance or the impact of currency unions

Keywords: Aggregative Game, CES Demand, Gravity Equation, oligopoly

JEL Classification: F12, F14, L13

Suggested Citation

Breinlich, Holger and Fadinger, Harald and Nocke, Volker and Schutz, Nicolas, Gravity with Granularity (October 2020). CEPR Discussion Paper No. DP15374, Available at SSRN: https://ssrn.com/abstract=3723563

Holger Breinlich (Contact Author)

University of Surrey - School of Economics ( email )

Guildford, Surrey GU2 7XH
United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Harald Fadinger

University of Mannheim ( email )

Universitaetsbibliothek Mannheim
Zeitschriftenabteilung
Mannheim, 68131
Germany

Volker Nocke

University of Mannheim ( email )

Nicolas Schutz

University of Mannheim ( email )

D-68131 Mannheim
Germany

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