Demand Uncertainty, Selection, and Trade

This paper shows that the information available to firms affects participation decision of exporters and therefore the social value of trade. When firms have complete information about profitability in foreign markets, selection into exporting is stringent as firms would not knowingly enter an unprofitable market. With incomplete information, a larger number of firms engage in risky export activity - both firms that will be profitable and unprofitable after learning their demand. Although trade flows are more elastic to changes in variable trade costs under incomplete information, the welfare gains from trade are lower because more (ex post) unprofitable firms enter the market. We obtain these results from a structural trade model that accommodates varying the degree of firm-level uncertainty. We prove the results theoretically, then quantify the magnitude of gains from trade using Brazilian microdata to estimate model parameters, and finally estimate a gravity equation that lends support to the model's testable implications.