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Estimation of the Gravity Equation in the Presence of Zero Flows

Author

Listed:
  • Gert-Jan M. Linders

    (Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam)

  • Henri L.F. de Groot

    (Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam)

Abstract
The gravity model is the workhorse model to describe and explain variation in bilateral trade patterns. Consistent with both Heckscher-Ohlin models and models of imperfect competition and trade, this versatile model has proven to be very successful, explaining a large part of the variance in trade flows. However, the log-linear model cannot straightforwardly account for the occurrence of zero-valued trade flows between pairs of countries. This paper investigates the various approaches suggested to deal with zero flows. Apart from the option to omit the zero flows from the sample, various extensions of Tobit estimation, truncated regression, probit regression and substitutions for zero flows have been suggested. We argue that the choice of method should be based on both economic and econometric considerations. The sample selection model appears to fit both considerations best. Moreover, we show that the choice of method may matter greatly for the results. In the end, the results surprisingly suggest that the simplest solution, to omit zero flows from the sample, often leads to acceptable results, although the sample selection model is preferred theoretically and econometrically.

Suggested Citation

  • Gert-Jan M. Linders & Henri L.F. de Groot, 2006. "Estimation of the Gravity Equation in the Presence of Zero Flows," Tinbergen Institute Discussion Papers 06-072/3, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20060072
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    bilateral trade; gravity model; zero flows; sample selection model;
    All these keywords.

    JEL classification:

    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F15 - International Economics - - Trade - - - Economic Integration

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