Controlling for Heterogeneity in Gravity Models of Trade and Integration

Federal Reserve Bank of St. Louis Review, Vol. 87, No. 1, pp. 49-63, 2005

Posted: 29 Jan 2005

See all articles by I-Hui Cheng

I-Hui Cheng

National University of Kaohsiung - Department of Applied Economics

Howard J. Wall

Lindenwood University - Center for Economics and the Environment

Abstract

This paper argues that it is necessary to allow for country-pair heterogeneity when using the gravity model to estimate international trade flows. We propose and estimate a fixed-effects model that eliminates the heterogeneity bias inherent in standard methods. Further, we show that there is no statistical support for the restrictions necessary to obtain existing empirical models, which are special cases of our model. Because the gravity model has become the 'workhorse' baseline model for estimating the effects of international integration, this has important empirical implications. In particular, our results suggest that standard gravity estimates of the effects of integration can differ a great deal from what is obtained when heterogeneity is accounted for.

Keywords: Gravity Model, Bilateral Trade

JEL Classification: F15, F17

Suggested Citation

Cheng, I-Hui and Wall, Howard J., Controlling for Heterogeneity in Gravity Models of Trade and Integration. Federal Reserve Bank of St. Louis Review, Vol. 87, No. 1, pp. 49-63, 2005, Available at SSRN: https://ssrn.com/abstract=656201

I-Hui Cheng

National University of Kaohsiung - Department of Applied Economics ( email )

700, Kaohsiung University Rd.
National University of Kaohsiung
Kaohsiung, 811
Taiwan

Howard J. Wall (Contact Author)

Lindenwood University - Center for Economics and the Environment ( email )

209 S. Kingshighway
St. Charles, MO 63301
United States

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