Heterogeneous effects of preferential trade agreements: How does partner similarity matter?

This paper empirically examines whether and how similarity in country characteristics affects the changes in trade flows amongst member countries under a preferential trade agreement (PTA). It demonstrates that accounting for similarity in size, income and loca- tion of member countries is important in obtaining unbiased estimates of the trade cre- ation effect of PTAs. Using both a nonparametric stratification and a parametric interaction term approach, we obtain consistent results that the more similar the member countries are in terms of size, income or location, the larger the level and the proportion increase in intra-bloc trade under a PTA. Extensive sensitivity analyses that account for potential biases due to self-selection of trade, the extensive margin of trade and omission of trade diversion variables confirm the robustness of our results.