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Gravity Models and the Law of Large Numbers

Author

Listed:
  • Colin Jareb
  • Sergey K. Nigai
Abstract
Modern quantitative theories of international trade rely on the probabilistic representation of technology and the assumption of the Law of Large Numbers (LLN), which ensures that when the number of traded goods goes to infinity, trade flows can be expressed via a deterministic gravity equation that is log-linear in exporter-specific, importer-specific and bilateral trade cost components. This paper shows that when the number of traded goods is finite, the gravity equation has a structural stochastic component not related to the fundamental gravity forces. It provides a novel explanation of the differences in the goodness of fit of gravity models across different sectors observed in the data. It also suggests that when the LLN does not hold, the welfare gains from trade have a considerable stochastic component and should be characterized via distributions rather than point estimates. We use sectoral trade data and Monte Carlo simulations to develop a procedure with minimal data requirements that allows estimation of intervals for the welfare gains from trade.

Suggested Citation

  • Colin Jareb & Sergey K. Nigai, 2020. "Gravity Models and the Law of Large Numbers," CESifo Working Paper Series 8548, CESifo.
    • Handle: RePEc:ces:ceswps:_8548
    as

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    References listed on IDEAS

    as
    1. Thomas Chaney, 2008. "Distorted Gravity: The Intensive and Extensive Margins of International Trade," American Economic Review, American Economic Association, vol. 98(4), pages 1707-1721, September.
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    More about this item

    Keywords

    trade gravity; Law of Large Numbers; gains from trade;
    All these keywords.

    JEL classification:

    • F10 - International Economics - - Trade - - - General
    • F60 - International Economics - - Economic Impacts of Globalization - - - General
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F17 - International Economics - - Trade - - - Trade Forecasting and Simulation

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