Equilibrium trust

Trusting beliefs — a players’ subjective probability of not being cheated — can be exploited. However, if a trustful player is cheated too often, she should change her belief and start trusting less, until her beliefs are correct. For this reason we model trust as an equilibrium phenomenon. Players receive an offer to transact and choose whether or not to cheat and steal the entire surplus. Cheating entails a cost, which has an idiosyncratic component and a socially determined one, increasing with the mass of players who do not cheat. The model can have a unique equilibrium level of trust (the proportion of transactions not cheated on), or two equilibria, one with high and one with low trust. Differences in trust across societies can therefore result from different fundamentals or from different equilibria being realized, supported by the same fundamentals. Surprisingly, under certain conditions these two alternatives are partially identifiable from an empirical point of view. Our model can be reinterpreted as one where the cost of cheating arises from an enforcement mechanism that punishes cheaters in a targeted way using limited resources. JEL Classification: D80, D89, C79.