The gravity model for international trade: Specification and estimation issues in the prevalence of zero flows

The gravity model for international trade is one of the most
successful empirical models in trade literature. There is a long tradition to log-linearise the multiplicative model and to estimate the parameters of interest by least squares. But this practice is inappropriate for several reasons. First of all, bilateral trade flows are frequently zero and disregarding countries that do not trade with each other produces biased results. Second, log-linearisation in the presence of heteroscedasticity leads to inconsistent estimates in general.
In recent years, the Poisson gravity model along with pseudo maximum likelihood estimation methods have become popular as a way of dealing with such econometric issues as arise when dealing with origin-destination
flows. But the standard Poisson model specification
is vulnerable to problems of overdispersion and excess zero
flows. To overcome these problems, this paper presents zero-inflated extensions of the Poisson and negative binomial specifications as viable alternatives to both the log-linear and the standard Poisson specifications of
the gravity model. The performance of the alternative model specifications is assessed on a real world example, where more than half of country-level trade flows are zero.