Journal of Eurasian Studies

October-December 2012 JOURNAL OF EURASIAN STUDIES Volume IV., Issue 4.
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Regional Trade Agreements Information System (RTA-IS) (WTO, 2012). The variable includes bilateral
and multilateral agreements. COMij accounts for a former membership in the COMECON. It equals one
if both countries were members of the COMECON and zero if that is not the case. The variable
represents the impact of traditional and continuing trade relations. As the Soviet Union and its partner
were highly integrated economically, the sign of this variable is expected to be positive.
2.3 Econometric Model and Estimation Procedure
One can argue that – due to the panel structure of the GMIT – a fixed effects model (FEM) or a
random effects model (REM) outperform the ordinary least squares (OLS) estimates because countryspecific
and time-specific effects are appropriately taken into consideration. Most scholars also agree that
the FEM is superior to the REM. This is because it is likely that country-specific effects and the error term
are correlated, which makes the REM yield biased estimation results. Moreover, statistical test like the
Hausman test mostly ends in favour of the FEM. In contrast to the REM, the FEM is not able to consider
time-invariant effect, which makes it difficult to apply in the context of this study. This makes it
necessary to use a different estimation procedure.
In their recent paper, Santos Silva and Tenreyro (2006) raised further concerns about biases of the
traditional econometric approach. They identified three problems of the log-linearised gravity model
which normally result in severely biased results. Above all, the log-model is based on the assumption
that the error terms do not exhibit heteroskedasticity. Also the log-linearisation creates biases as the
transformation has an effect on the nature of the estimation procedure. Lastly and most severe, the log
model cannot deal with zero trade flows. Most scholars cope with the problem by dropping zero trade
flows or modifying the dependent variable. Notably, this modifications lack any theoretical justification.
To avoid these problems, Santos Silva and Tenreyro (2006) proposed using levels instead of lags for
the dependent variable. They suggest applying the Poisson pseudo-maximum-likelihood (PPML)
estimation procedure. Among others, Siliverstovs and Schumacher (2009) confirm that PPML
outperforms traditional estimation procedures. According to Santos Silva and Tenreyro (2006) and based
on Equation 2, I developed an augmented gravity model and specified it as follows:
α1 α2 α3 α4
α5 α6
EXP ln α ln X ln X ln DW Linder RTA COM η
(3)
ijt 0 it jt ij ijt ijt ij ijt
This relation is estimated by the Poisson pseudo-maximum-likelihood (PPML) estimator. The form of
Equation 3 makes clear that the data does not have to be Poisson or integer to receive consistent
estimators. Particularly in the presence of heteroskedasticity, the Poisson regression estimates are more
efficient and consistent than the least squares regression estimates. Moreover, the PPML method
provides a natural way to cope with zero trade. To obtain a robust variance estimate that adjusts for
within-cluster correlation, I clustered the data by the partner country. This allows for a
heteroskedasticity-robust variance estimator (Williams, 2000).
Furthermore, to check for the adequacy of the estimated model, I perform a heteroskedasticity-robust
version of the Ramsey Regression Equation Specification Error (RESET) test (Ramsey, 1969). It tests for
the correct specification of the conditional expectation. If the RESET test p-value is insignificant, the test
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