The Log of Gravity

43 Pages Posted: 30 Dec 2005

See all articles by J. M.C. Santos Silva

J. M.C. Santos Silva

University of Surrey

Silvana Tenreyro

London School of Economics (LSE)

Multiple version iconThere are 2 versions of this paper

Date Written: October 2005

Abstract

Although economists have long been aware of Jensen's inequality, many econometric applications have neglected an important implication of it: the standard practice of interpreting the parameters of log-linearized models estimated by ordinary least squares as elasticities can be highly misleading in the presence of heteroskedasticity. This paper explains why this problem arises and proposes an appropriate estimator. Our criticism of conventional practices and the solution we propose extends to a broad range of economic applications where the equation under study is log-linearized. We develop the argument using one particular illustration, the gravity equation for trade, and apply the proposed technique to provide new estimates of this equation. We find significant differences between estimates obtained with the proposed estimator and those obtained with the traditional method.

Keywords: Elasticities, gravity equation, heteroskedasticity, Jensen's inequality, poisson regression

JEL Classification: C13, C21, F10, F11, F12, F15

Suggested Citation

Santos Silva, João M.C and Tenreyro, Silvana, The Log of Gravity (October 2005). CEPR Discussion Paper No. 5311, Available at SSRN: https://ssrn.com/abstract=872865

João M.C Santos Silva (Contact Author)

University of Surrey ( email )

Guildford
Surrey GU2 7XH
United Kingdom

Silvana Tenreyro

London School of Economics (LSE) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

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