Gravity equations explaining foreign affiliates’ sales are ad hoc and hence, estimated coefficients are hard to interpret. We therefore provide the theoretical
underpinnings of the gravity equation applied to the analysis of sales of foreign
affiliates of multinational firms. We argue that the success of the gravity
equation results from the fact that it can be derived from various theoretical
models. We illustrate this point by deriving a gravity equation from three
different models of multinational firms. Using data on real affiliate sales, we
show how this derived gravity equation can nevertheless be used to discriminate
between the different theoretical models