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The Log of Gravity

João Santos Silva1; Silvana Tenreyro2

1 ISEG/Universidade Técnica de Lisboa and CEMAPRE · 2 London School of Economics, CEP, and CEPR

The Review of Economics and Statistics 2006 open access

Abstract Although economists have long been aware of Jensen's inequality, many econometric applications have neglected an important implication of it: under heteroskedasticity, the parameters of log-linearized models estimated by OLS lead to biased estimates of the true elasticities. We explain why this problem arises and propose an appropriate estimator. Our criticism of conventional practices and the proposed solution extend to a broad range of applications where log-linearized equations are estimated. We develop the argument using one particular illustration, the gravity equation for trade. We find significant differences between estimates obtained with the proposed estimator and those obtained with the traditional method.

DOI
10.1162/rest.88.4.641
Volume
88 (4)
Pages
641-658
Language
en
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