AbstractDo firms engaging in international trade have higher or lower profit margins? It is well established that more productive firms engage in trading activities and as a result have higher profit levels. We use two theoretical models (the Melitz model and the Egger–Kreickemeier model) to clarify the relationship between productivity, trade activity, and profit margins and derive three hypotheses: (I) profit margins rise as productivity rises for domestic firms; (II) profit margins rise as productivity rises for trading firms; and (III) profit margins are not higher for trading firms than for domestic firms. We test these hypotheses using detailed micro‐data for Finland (2005–10) and the Netherlands (2002–10). We find strong support for Hypothesis I (in favour of the Melitz model), Hypothesis II (in favour of both models) and Hypothesis III (in favour of the Egger–Kreickemeier model). A propensity score matching analysis provides further support for Hypothesis III.