Discussion paper

DP5137 Trade Costs, Trade Balances and Current Accounts: An Application of Gravity to Multilateral Trade

In this paper we test the well-known hypothesis of Obstfeld and Rogoff (2000) that trade costs are the key to explaining the so-called Feldstein-Horioka puzzle. Using a gravity framework in an intertemporal context, we provide strong support for the hypothesis and we reconcile our results with the so-called home bias puzzle. Interestingly, this requires fundamental revision of Obstfeld and Rogoff?s argument. A further novelty of our work is in tying bilateral trade behaviour to desired aggregate trade balances and desired intertemporal trade.

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Citation

MELITZ, J, R MacDonald and G Fazio (eds) (2005), “DP5137 Trade Costs, Trade Balances and Current Accounts: An Application of Gravity to Multilateral Trade”, CEPR Press Discussion Paper No. 5137. https://cepr.org/publications/dp5137