Competing specifications of the gravity equation: a three-way model, bilateral interaction effects, or a dynamic gravity model with time-varying country effects?

Robert Kunst, Elif Nuroglu

Publications: Contribution to journalArticlePeer Reviewed

Abstract

We investigate bilateral trade flows across the EU-15 countries from 1962 to 2003 by different specifications of the gravity model. We augment the basic gravity model with population and exchange rate variables, and then include time-varying country fixed effects, to account for Anderson and van Wincoop (Am Econ Rev 93(1):170-192, 2003) multilateral resistance terms. Then, following the previous theoretical derivations of the gravity model in the presence of panel data in a dynamic setting we change the specification of our gravity model. We compare the results of different specifications showing the improvement in each case. We claim the comparative superiority of the dynamic gravity model with time-varying exporter and importer fixed effects due to its higher explanatory power. Finally, we compare out-of-sample forecasting performance of different specifications of the gravity model.

Original languageEnglish
Pages (from-to)733-741
Number of pages9
JournalEmpirical Economics: a quarterly journal of the Institute for Advanced Studies, Vienna
Volume46
Issue number2
DOIs
Publication statusPublished - Mar 2014

Austrian Fields of Science 2012

  • 502003 Foreign trade
  • 502025 Econometrics

Keywords

  • Bilateral interaction effects
  • Dynamic gravity
  • Exporter effects
  • Gravity model
  • Importer effects
  • Time effects
  • Time varying fixed effects

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