25
Where P1 is the price in the central market,
Pi
is the price in the ith
local market, X is a vector of other influences (e.g., inflation, seasonality indices) and the e’s are error terms. Ravallion applied his model to Bangladesh and concluded that the results suggest the existence of substantial impediment to trade between Dhaka and its main rural supply areas.
The Ravallion error-correction model allows the testing for market segmentation between the central market and a given local market; i.e., bij = 0 .
It also allows for short run market integration; i.e., bi 0 = 1 . It
also allows for market integration with the central market within one time period;
bi 0 = 1 and
a ij = bij = 0
( j = 1, ‌., N).
With some
reformulation, the model also allows for long run market integration.
The Ravallion model can be transformed into an error correction representation of a cointegrated sytem (Barrett, 1996). Two stationary price series are cointegrated if there exists a stable long run linear relationship between them. The presence of cointegration in both directions between the two price series is indicative of interdependence. The absence of cointegration in both directions is indicative of market segmentation.
However, the Ravallion model has its weaknesses. The model assumes that price shocks originate from the central (urban) market, which is plausible for demand shocks but not for supply shocks. The model and the related cointegration analyses assume constant intermarket transfer costs that are either additive or proportional. If in fact transfer costs are time varying, then the Ravallion model’s inference is biased in favor of market segmentation. In addition, where there are discontinuous trade flows and strong seasonality patterns in agricultural demand, supply and transactions