29 Pages Posted: 18 Sep 2010
Date Written: September 15, 2010
Trust is an important determinant of economic development. Understanding its origins is therefore critical. We develop a principal-agent model with heterogeneous players to determine the aggregate amount of trustworthiness and trust in a society. People are distributed according to their preference toward caution, which we model as loss aversion. The first two moments of the distribution across principals and agents -- along with institutional quality -- are critical to the process by which trustworthiness and trust are formed. A direct effect suggests that more caution leads to less societal trust. An indirect effect of greater caution, working through trustworthiness, leads to more trust. Paradoxically, the net effect is almost always positive. The results are similar when we use expected utility theory, but social preferences like betrayal aversion may temper the results.
Keywords: trust, trustworthiness, culture, risk, development
JEL Classification: C7, O1, Z1
Suggested Citation: Suggested Citation