Structural Estimation of a Gravity Model of Trade with the Constant-Difference-of-Elasticities Preferences
This paper presents a general equilibrium gravity model of trade based on the preferences of the constant difference of elasticities of substitution. Hanoch (1975) illustrates its advantages in terms of parsimony and flexibility. It is the first parsimonious non-homothetic model introduced into the gravity model that both separates substitution effects from income effects and has non-constancy substitution elasticities. These features of the demand model—together with the structural estimation procedure devised in this paper—allow nesting several prominent theoretical motivations (e.g., the standard and non-homothetic CES models) for the gravity model, and exploring the merits of this more general model. They also allow identifying the elasticity of trade costs with respect to distance and asymmetric border coefficients from the elasticity of trade flows with respect to trade costs, that are not easily identified in most previous studies.