Instrumental-Variable Estimation Of Exponential Regression Models With Two-Way Fixed Effects With An Application To Gravity Equations

Abstract

This paper introduces instrumental-variable estimators for exponential-regression models that feature two-way fixed effects. These techniques allow us to develop a theory-consistent approach to the estimation of cross-sectional gravity equations that can accommodate the endogeneity of policy variables. We apply this approach to a data set in which the policy decision of interest is the engagement in a free trade agreement. We explore ways to exploit the transitivity observed in the formation of trade agreements to construct instrumental variables with considerable predictive ability. Within a bilateral model, the use of these instruments has strong theoretical foundations. We obtain point estimates of the partial effect of a preferential-trade agreement on trade volume that range between 20% and 30% and find no statistical evidence of endogeneity.

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Replaces

Koen Jochmans, and Vincenzo Verardi, “Instrumental-Variable Estimation Of Exponential Regression Models With Two-Way Fixed Effects With An Application To Gravity Equations”, TSE Working Paper, n. 21-1271, November 19, 2021.

Reference

Koen Jochmans, and Vincenzo Verardi, “Instrumental-Variable Estimation Of Exponential Regression Models With Two-Way Fixed Effects With An Application To Gravity Equations”, Journal of Applied Econometrics, vol. 37, n. 6, July 2022, pp. 1121–1137.