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The log of gravity

Santos Silva, Joao and Tenreyro, Silvana (2005) The log of gravity. 701. Centre for Economic Performance, London School of Economics and Poltical Science, London, UK.

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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 to 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. These discrepancies persist even when the gravity equation takes into account multilateral resistance terms or fixed effects

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk/
Additional Information: © 2005 J. Santos Silva and S. Tenreyro
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Journal of Economic Literature Classification System: F - International Economics > F1 - Trade > F10 - General
F - International Economics > F1 - Trade > F11 - Neoclassical Models of Trade
F - International Economics > F1 - Trade > F15 - Economic Integration
C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods: General > C13 - Estimation
F - International Economics > F1 - Trade > F12 - Models of Trade with Imperfect Competition and Scale Economies
C - Mathematical and Quantitative Methods > C2 - Econometric Methods: Single Equation Models; Single Variables > C21 - Cross-Sectional Models; Spatial Models; Treatment Effect Models
Sets: Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Departments > Economics
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 701
Date Deposited: 06 Mar 2008 12:04
URL: http://eprints.lse.ac.uk/3744/

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