ORIGINAL PAPER Gravity models in integrated panels

Abstract This paper shows that standard gravity models of foreign trade include non-stationary variables (bilateral trade and GDP of trading partners). Furthermore, gravity models are characterized by inherited cross-sectional correlation between the panel units (country pairs). Therefore, the results of the standard panel unit root tests are biased and outperformed by the simple cross-sectionally augmented panel unit root test according to Pesaran (J Appl Econom 22:265–312, 2007). Nevertheless, the fixed effects estimator is similar to the dynamic OLS or fully modified OLS, which take into account the non-stationarity of analyzed macroeconomic variables as well as possible endogeneity between output and trade