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Working Paper
Gravity-defying trade
Heteroskedasticity and the existence of zero values in bilateral-trade data lead to significant biases in standard estimations of the gravity equation. We propose a new estimation technique that addresses these problems, and provide novel estimates of the gravity equation. Three results stand out. First, contrary to general belief, income elasticities are significantly smaller than 1, suggesting modifications to standard trade models. Second, simple estimators of the gravity equation greatly exaggerate the roles of distance and colonial links. Finally, bilateral trade between countries that ...