Community Enforcement of Trust∗

We examine how trust is sustained in large societies with random matching, when the player to be trusted may default voluntarily or involuntarily. In order to incentivize trustworthiness, defaulters should be punished through temporarily exclusion.The difficulty is that trusting defaulters who are the verge of rehabilitation is profitable. With perfect bounded information, defaulter exclusion unravels and trust cannot be sustained. A coarse information structure that pools recent defaulters with those nearing rehabilitation endogenously generates adverse selection, sustaining the temporary exclusion of defaulters. Equilibria where defaulters are trusted with positive probability improve efficiency, since mixing raises the proportion of likely re-offenders in the pool of defaulters. Our results extend to a large class of sequential-move games. JEL codes: C73, D82, G20, L14, L15.