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Trade Creation and Diversion Revisited: Accounting for Model Uncertainty and Natural Trading Partner Effects

Author/Editor: Eicher, Theo | Henn, Christian | Papageorgiou, Chris
Authorized for Distribution: March 1, 2008
Electronic Access: Free Full Text (PDF file size is 405KB)
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Summary: Trade theories covering Preferential Trade Agreements (PTAs) are as diverse as the literature in search of their empirical support. To account for the model uncertainty that surrounds the validity of the competing PTA theories, we introduce Bayesian Model Averaging (BMA) to the PTA literature. BMA minimizes the sum of Type I and Type II error, the mean squared error, and generates predictive distributions with optimal predictive performance. Once model uncertainty is addressed as part of the empirical strategy, we report clear evidence of Trade Creation, Trade Diversion, and Open Bloc effects. After controlling for natural trading partner effects, Trade Creation is weaker - except for the EU. To calculate the actual effects of PTAs on trade flows we show that the analysis must be comprehensive: it must control for Trade Creation and Diversion as well as all possible PTAs. Several prominent control variables are also shown to be robustly related to Trade Creation; they relate to factor endowments and economic policy.
 
Series: Working Paper No. 08/66
Subject(s): Trade | Trade liberalization | Trade models
Author's keyword(s): Trade Creation and Trade Diversion | Preferential Trade Agreements | Bayesian Model Averaging | Country-Pair Fixed Effects.
 
English  
    Published:   March 1, 2008        
            Format:   Paper
    Stock No:   WPIEA2008066   Pages:   30
    Price:   US$18.00
       
     
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