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The B.E. Journal of Economic Analysis & Policy

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Trade Potentials in Gravity Panel Data Models

Luca De Benedictis1 / Claudio Vicarelli2

1DIEF - University of Macerata - Italy,

2ISAE, Institute for Studies and Economic Analyses, Rome, Italy,

Citation Information: The B.E. Journal of Economic Analysis & Policy. Volume 5, Issue 1, ISSN (Online) 1935-1682, ISSN (Print) 2194-6108, DOI: 10.1515/1538-0653.1386, September 2005

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This article offers supplementary material which is provided at the end of the article.


The paper shows how - using as an example the trade flows between eleven European countries and 31 OECD `reporting' countries - the result of a gravity model, in terms of potential trade, changes substantially when country heterogeneity and dynamics are taken into account.

Comparing the in-sample trade potential index derived from various estimators yields three different results: (a) the average trade potential index poorly represents the distribution of yearly trade potentials; (b) the index converges towards the demarcation value corresponding to the equality between observed and predicted trade flows when country heterogeneity and dynamics are taken into account; (c) the sign of its yearly average is not the right statistic with which to determine the (in)existence of unrealized trade potentials.

Finally, the index derived from a dynamic specification with multilateral fixed-effects is better able to reflect the role played by the time-variant country-specific unobservable element associated with the possible presence of positive or negative trade potentials.

Keywords: International bilateral trade; Gravity model; Trade potentials; Dynamic Panel Data; System-GMM estimator

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