Controlling for Heterogeneity in Gravity
Models of Trade and Integration


I-Hui Cheng
and
Howard J. Wall


Working Paper 1999-010D
http://www.pinggu.org/bbs/viewthread.php?tid=397908&page=1&from^^user=wusi126

Revised May2003
FEDERAL RESERVE BANK OF ST. LOUIS
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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 general fixed-effects model to eliminate the heterogeneity bias inherent in standard methods.We also compare our model to other fixed-effects models, all of which are special cases of ours.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.(JEL F15, F17)