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Enhanced Gravity Model of trade: reconciling macroeconomic and network models

Almog, Assaf and Bird, Rhys and Garlaschelli, Diego Enhanced Gravity Model of trade: reconciling macroeconomic and network models. Working Paper arXiv (Submitted)

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The structure of the International Trade Network (ITN), whose nodes and links represent world countries and their trade relations respectively, affects key economic processes worldwide, including globalization, economic integration, industrial production, and the propagation of shocks and instabilities. Characterizing the ITN via a simple yet accurate model is an open problem. The traditional Gravity Model successfully reproduces the volume of trade between connected countries, using macroeconomic properties such as GDP, geographic distance, and possibly other factors. However, it predicts a network with complete or homogeneous topology, thus failing to reproduce the highly heterogeneous structure of the ITN. On the other hand, recent maximum-entropy network models successfully reproduce the complex topology of the ITN, but provide no information about trade volumes. Here we integrate these two currently incompatible approaches via the introduction of an Enhanced Gravity Model (EGM) of trade. The EGM is the simplest model combining the Gravity Model with the network approach within a maximum-entropy framework. Via a unified and principled mechanism that is transparent enough to be generalized to any economic network, the EGM provides a new econometric framework wherein trade probabilities and trade volumes can be separately controlled by any combination of dyadic and country-specific macroeconomic variables. The model successfully reproduces both the global topology and the local link weights of the ITN, parsimoniously reconciling the conflicting approaches. It also indicates that the probability that any two countries trade a certain volume should follow a geometric or exponential distribution with an additional point mass at zero volume.

Item Type: Working Paper (Working Paper)
Identification Number: arXiv:1506.00348
Uncontrolled Keywords: Econophysics, Networks
Subjects: Q Science > QC Physics
Research Area: Economics and Institutional Change
Depositing User: Caterina Tangheroni
Date Deposited: 09 Mar 2018 13:45
Last Modified: 09 Mar 2018 13:45
URI: http://eprints.imtlucca.it/id/eprint/4039

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